Smart contracts pose enforceability issues

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A new white paper by blockchain consortium R3 and global law firm Norton Rose Fulbright explores whether blockchain-based “smart contracts” are legally binding under current legislation in different countries.

Smart contracts are blockchain-based contracts that execute automatically and immediately when certain conditions coded into the contract are met.

Here are the white paper’s main findings:

  • There are many possible smart contract models. The study identifies two smart contract concepts on either end of a spectrum: the first encodes an entire natural language contract in digital form; the other encodes only the “active” parts of a contract that depend on certain conditions being met — for example, payment. In between, there is a “split” contract written in natural language, but with various data-driven elements that are administered by smart contracts. These split contracts are simpler to create, according to the report, and could be used by financial services firms to achieve greater standardization in data formats.
  • Whether or not smart contracts are legally binding partly depends on the jurisdiction. There have been advances in many countries regarding the legal acceptability of electronic contracts, which are likely to carry over to smart contracts. This should give industries looking to benefit from smart contracts — the insurance and securities industries, in particular, have expressed interest in the technology — hope that it will not be too difficult for legal frameworks to be created for smart contracts.
  • Smart contracts’ underlying technology presents enforceability issues. This is particularly true where contracts are built on permissionless blockchains, which do not allow for a central controlling authority. Since the point of such blockchains is to decentralize authority, they might not provision for an arbitrator to resolve any disputes that arise over a contract that is executed automatically. This is likely why many financial firms considering smart contracts are working on permissioned blockchains.
  • Smart contracts should embed dispute resolution mechanisms to reduce friction. For example, a smart contract could include a clause that delegates a matter to an external arbitrator if the parties involved disagree about the contract. This is especially pertinent to insurers, which often deal with contentious claims.

Smart contracts have many business benefits, but there are clearly still legal hurdles to overcome. The challenges identified in this white paper show it’s imperative that legislators, fintechs, and financial regulators find a forum in which to iron out the details of the new technology. This will be necessary to determine whether smart contracts fit into existing legal frameworks, and what new measures must be introduced to accommodate them if they do not. It seems likely that legal precedent will have to be established before financial services providers can onboard this technology.

However, it is worth bearing in mind that major regulators in the EU and UK are already actively exploring blockchain more generally, and may well be considering the implications of smart contracts under this umbrella.

Blockchain technology, which is best known for powering Bitcoin and other cryptocurrencies, is gaining steam among finance firms because of its potential to streamline processes and increase efficiency. The technology could cut costs by up to $20 billion annually by 2022, according to Santander.

That’s because blockchain, which operates as a distributed ledger, has the ability to allow multiple parties to transfer and store sensitive information in a space that’s secure, permanent, anonymous, and easily accessible. That could simplify paper-heavy, expensive, or logistically complicated financial systems, like remittances and cross-border transfer, shareholder management and ownership exchange, and securities trading, to name a few. And outside of finance, governments and the music industry are investigating the technology’s potential to simplify record-keeping.

As a result, venture capital firms and financial institutions alike are pouring investment into finding, developing, and testing blockchain use cases. Over 50 major financial institutions are involved with collaborative blockchain startups, have begun researching the technology in-house, or have helped fund startups with products rooted in blockchain.

Jaime Toplin, research associate for BI Intelligence, Business Insider’s premium research service, has compiled a detailed report on blockchain technology that explains how blockchain works, why it has the potential to provide a watershed moment for the financial industry, and the different ways it could be put into practice in the coming years.

Here are some key takeaways from the report:

  • Spending on capital markets applications of blockchain is expected to grow at a 52% compound annual growth rate (CAGR) through 2019, according to Aite Group, to reach $400 million that year.
  • Banks and major financial institutions are working both collaboratively and independently to develop blockchain tech. Over 50 major financial institutions are involved with collaborative blockchain startups, like R3 CEV or Chain. And many are investing in the technology on their own as well.
  • Putting blockchain to use for real-world transactions is likely not that far off. If working groups’ tests are successful, firms could be using it to transact real value as early as the end of this year and we could see widespread industry application within the next few years.

In full, the report:

  • Examines the funding increases that are pouring into blockchain
  • Assesses why blockchain is becoming so popular and what factors are driving up increased research and development
  • Explains in full how blockchain technology work and what assets make it valuable and vulnerable
  • Identifies pain points in the financial industry and profiles how various firms are using blockchain to solve them
  • Demonstrates the challenges to mainstream adoption and their potential solutions

To get your copy of this invaluable guide, choose one of these options:

  1. Subscribe to an ALL-ACCESS Membership with BI Intelligence and gain immediate access to this report AND over 100 other expertly researched deep-dive reports, subscriptions to all of our daily newsletters, and much more. >> START A MEMBERSHIP
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The choice is yours. But however you decide to acquire this report, you’ve given yourself a powerful advantage in your understanding of blockchain technology.