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What’s a Smart Contract? And Why Should Treasurers Care?

  • By Andrew Deichler
  • Published: 12/1/2016

NEW YORK -- During a panel session Tuesday morning at the Blockchain for Wall Street conference, experts debated the merit of smart contracts—computer protocols designed to execute contract terms. While these contracts could provide corporate treasurers with greater certainties over agreements made with their counterparties, the technology is still in its infancy and should be treated as such.

Attorney Joshua Ashley Klayman of Morrison Foerster provided attendees with a lawyer’s view of taking a physical contract and working with technologists to create a smart contract out of it. “The first thing we do is, we say, ‘We’re lawyers—we’re not computer programmers who have large insurance policies who can ensure that we’re going to match up one-to-one with your words.’ A lot of what we’re doing is actually helping figure out decision trees for how one might create, conceptually, a contract that could then be programmed. But we take a position that we’re not actually doing the code and we’re not responsible for the code,” she said.

Keeping it simple

Klayman noted that her firm advises clients that to keep smart contracts simple given that they are still so new and there are a lot of gray areas around them. “I think one of the challenges that a lot of clients are struggling with is how you can make sure the code matches what you think you have in the contract,” she said. “In a legal contract, you don’t want any ambiguity. When you sign your contract, you want to know exactly what is going to happen. And with the code, how are you sure that there are no bugs? How are you sure it matches what’s actually in your written contract? So right now, the simpler, the better.”

That lack of ambiguity is a double-edged sword for smart contracts, explained Ari Juels, professor, Cornell Tech and co-director of the Initiative for Cryptocurrencies and Contracts (IC3). “The beauty of a smart contract is that it specifies terms unambiguously,” he said. “One of the biggest drawbacks of smart contracts is that they specify terms unambiguously. Having some margin in which to maneuver, in which to reinterpret contracts or interpret them in ways in which they may not have initially been intended, is extremely challenging.”

Juels added that one of the biggest technical challenges in bringing smart contracts to fruition is enshrining ambiguity, i.e., building in the ability to change the terms of the contract within its code. “This is something we’re actually exploring, in the form of what we refer to as ‘escape hatches’—ways of altering the terms or terminating a smart contract if the situation warrants it and there’s agreement among a sufficient number of parties to make the change,” he said.

Bugs in the system

Moderator Richard Johnson, vice president, market structure and technology for Greenwich Associates, asked the group what would happen if a bug in the system should cause a smart contract to misfire. “How should that be undone? Should there be a central authority in these types of cases?” he asked.

Preston Byrne, COO and general counsel for Monax, responded that someone is “god” in most transactions, if you look closely at the terms. “So if you’re in a bond transaction, it will be a bondholder representative, etc.,” he said. “So if you’re using the blockchain as a reconciliation tool, then you’ve got a really good record of evidence of what went. It doesn’t really matter whether you’ve got someone who is able to step in and correct a manifest error in the system. So generally you invest the control to override in one party, and if they exercise that particular right, it just updates everywhere at once and everyone sees that they stepped in because there’s an error in the way that payments are being processed.”

Johnson countered that if a party received a payment in their bank account and then had it taken back, they might object—even if said payment was made in error. Byrne responded that this is essentially the same thing as a chargeback, which retailers deal with on a regular basis. “We sign contracts which already do this today, it’s just not with a distributed system; it’s with a centralized system,” he said. “So the question is, what utility is there for a distributed system that does the same thing as our centralized systems do today?”

Legally binding?

Johnson noted that written contracts are contested all the time. He asked what would happen if someone contested a smart contract.

Klayman noted that smart contracts are still new and the answer to this question is still developing. “Assuming that you have a legally valid and binding contract—there’s a meeting of the minds and clear terms, depending on the nature and topic of the contract—then I think you could see them enforcing it,” she said. “As long as you have the elements of a legally binding contract, I think you could take someone to court.”

However, there is a question about whether smart contracts are actually legally binding. “I don’t know necessarily that if you write a code, that it is legally binding,” she said. “It think that’s more of a philosophy and something to be taken into account.”

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