Best Practices for Limiting Liability Arising from Smart Contract Vulnerabilities

It is no secret that smart contracts have vulnerabilities.  Today’s post suggests a mix of best practices to limit potential liabilities that may arise when vulnerabilities interfere with smart contract performance.

But first, some background:  One recent survey of 19,366 Ethereum-based contracts found vulnerabilities in 45% of them.  Perhaps the most publicized example of a vulnerability was the DAO hack in June of last year, but hacking is certainly not the only way that smart contracts may be compromised.  There is potential for manipulation by insiders, which is of particular concern for smart contracts that operate based on “proof of stake” protocols, given the ongoing concerns that those protocols will not be effective in ensuring that the parties play by the rules.  Even without intentional interference by hackers or insiders, smart contracts may have software bugs that disrupt performance, and there is the possibility of unintended outcomes if the smart contract’s code fails to anticipate an unusual situation.  (Consider, for example, a complicated contractual pricing formula that depends on several variables and may cause the price to drop or skyrocket simply because the variables align in unanticipated ways.)

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Tips for Drafting Arbitration Clauses in Smart Contracts

We have suggested previously that arbitration may be a preferable alternative to court for smart contract disputes to (i) ensure a knowledgeable decision-maker handles the dispute, (ii) protect proprietary information, (iii) gain flexibility in scheduling and procedures, and (iv) pre-select the right forum.  Of course, arbitration doesn’t happen on its own – it typically requires a properly drafted arbitration clause.  This article provides several suggestions to consider on that point.

Notwithstanding all the hype associated with smart contracts, the real-world applications on the immediate horizon make use of distributed ledger technology (DLT) in ways that are not likely to necessitate fundamental changes in the dispute resolution procedures in those contracts.  Consider the example of commercial lending.  A smart contract may include protocols for the use of DLT to disburse loan proceeds and manage payments, but the inherent limits of the technology make it ill-suited to resolve a borrower’s default, leaving that circumstance to be addressed by the legal terms in the contract in the same way a default would be addressed under a traditional contract. That said, there are some aspects of the arbitration clause that should be re-considered when dealing with smart contracts:

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Tax Coalition Forms to Address Digital Asset Uncertainty

The Chamber of Digital Commerce and Steptoe & Johnson LLP today announce the formation of the Digital Assets Tax Policy Coalition, a Washington, DC-based coalition created to help develop effective and efficient tax policies for the growing virtual currency markets.  The move comes in response to a lack of recent guidance from the Internal Revenue Service, which since 2014 has considered digital currencies to be property, not currency, for tax purposes.

The Digital Assets Tax Policy Coalition intends to help develop policies that work for both the industry and government.  Developing these policies will allow the IRS to implement the recent recommendations by the Treasury Inspector General for Tax Administration (TIGTA) that the IRS develop a strategic plan for its virtual currency program and create third-party tools to allow for greater compliance, while minimizing the need for aggressive and burdensome enforcement actions.

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Four Reasons to Put an Arbitration Clause in Your Company’s Smart Contracts

Many in the blockchain industry expect smart contracts to enjoy significant (perhaps exponential) growth in real-world applications beginning this year.  This was the general consensus at the industry’s first ever Smart Contract Symposium in New York City this past December.  More than 250 leaders in blockchain, finance, law, and other industries gathered at the Microsoft Technology Center to discuss and promote the adoption of smart contracts for commercial use.  The Digital Chamber of Commerce followed up with a whitepaper identifying twelve business use cases for this technology, ranging from simple identity verification and payment processing to more complex processes like supply chain management and even cancer research.

The bottom line is smart contracts are coming (and may have arrived already for some).  No doubt smart contracts will offer many benefits in terms of decreased transaction costs and increased transparency and security, but even the best-designed smart contracts may deviate at times from the outcomes anticipated by the parties and may have vulnerabilities that can be exploited by the parties or outsiders.  So what happens when contract disputes arise?  Particularly if you are in-house counsel (or if you count in-house counsel among your clients), how can you be sure that the historical best practices for dispute resolution will continue to yield optimal results?  Or even tolerable results?

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Steptoe joins the Global Blockchain Business Council (GBBC)

The Bitfury Group, the leading global full-service Blockchain technology company, in conjunction with Steptoe & Johnson LLP, issued a press release today that Steptoe will serve as the legal services partner of the Global Blockchain Business Council (GBBC). Jason Weinstein was also listed as one of the 32 founding members of the GBBC, which was launched around the World Economic Forum 2017 Annual Meeting in Davos, Switzerland. See the full press release below.

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Alan Cohn on Blockchain in 2017

CoinDesk quoted Alan Cohn in a December 30 article titled “A Slow Awakening: 2016 in US Blockchain Policy.” In the article, which discusses blockchain regulatory developments of the past year and what may lie ahead in 2017, Alan Cohn says: “If 2016 was the year that the blockchain burst into public view, 2017 is the year that blockchain pilots and proofs-of-concept begin to permeate the mainstream of industry.” With a number of new projects announced within the first few weeks of 2017 such as a collaboration between IBM and the FDA and Deloitte‘s new blockchain research lab, he may have hit the nail on the head.

Alan also predicts that in 2017 there will be a stronger focus on using blockchain technology “to solve real-world problems, starting with digitizing processes that have resisted technological solutions or automation because of fears around non-trusted counter-parties, multi-party transactions, insecure transaction records, and high rates of fraudulent activity, areas where blockchain technology offers stair-step advantages.” While only time will tell how the regulatory landscape will change, the activity in the past two weeks makes 2017 look like a promising year for the blockchain.


Insurance with Assurance

In the last installment of our five-part blockchain series, we focus on the insurance industry.  Insurance and reinsurance companies are actively exploring and developing applications for blockchain technology.  And for good reason – distributed ledger technology has the potential to revolutionize the way insurance companies operate and engage with their policyholders and to open a window into new products and new markets.

At the retail level, the blockchain promises to benefit both the consumer and insurer by simplifying the claims process, increasing efficiency of underwriting and claims handling, improving risk management, and reducing operational costs.  The blockchain will help ensure the security of private or confidential information, improve auditability and transparency, and increase effectiveness in fraud detection.  These enhancements will also help lead to an improved customer experience.

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Taking off on the Blockchain

In this fourth installment of our five-part series highlighting the legal issues presented by blockchain, we’ll consider application to the aviation industry. Blockchain has the potential to increase airlines’ profitability by lowering transaction costs as well as improving efficiency and transparency, while simultaneously enhancing customer experiences.

As we discussed in the post “Taking Control of Your Identity,” digital identity verification is difficult and lacks trust – problems the blockchain can solve. And where is identity verification more important than when you’re standing in a long check-in line at the airport? Securely storing passenger information and identification on the blockchain will streamline passenger identity verification and may even reduce those long lines. Different airlines, airports and other entities can use the same shared, secure blockchain to create a universal digital identity system, significantly reducing operational costs. One blockchain startup is already developing a digital token that would contain all of a passenger’s travel documents and passport/identification in one place.

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Can the Blockchain Block IP Theft?

Imagine a world where you could easily register and claim ownership over your original creative works – from music to photos to blogs. Gone would be the days of seeing your work duplicated all over the internet without proper credit and having no way to prove ownership. With the use of blockchain technology, that world is not so far away. Distributed ledger technology promises to transform the way intellectual property rights are established and enforced – and the way IP creators are compensated.

Before joining Steptoe, I oversaw the Justice Department’s IP criminal enforcement program.  In that role, I worked closely with others in law enforcement and with the content industry – from film and television to publishing to music – in an effort to try to stop piracy and to ensure that artists and creators of all types of IP were protected.  At that time, the world was just beginning to hear about Bitcoin but had yet to discover the many other applications for blockchain technology that go far beyond digital currencies.

Today, however, as “blockchain” is on its way to becoming a household word, we’re poised for a revolution in the protection of all types of IP.  That’s because the blockchain can be used to control and track the distribution of protected IP.  By putting IP on the blockchain, creators would have an immutable, secure, time-stamped record of the creation and distribution of their works.  In addition, it can be used to establish and enforce licenses for IP through smart contracts and even to transmit payments in real-time to IP owners.

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Taking Control of Your Identity

One of the most intriguing uses of the blockchain may be the enhancement of identity solutions.

As we know, the blockchain offers enhancements over current mechanisms for creating and storing digital identities, such as security and resilience built in by design, a greater ability to control the uses of encrypted information, and the ability to provide standardization across a range of legacy IT systems.  But what does this actually mean for identity applications in different industries?

A lot, actually.  Identity validation for internet applications is a persistent problem.  As the New Yorker cartoon famously says, “On the Internet, nobody knows you’re a dog.”  Yet as we have seen, the use of fraudulent identity on the internet leads to mistrust in electronic transactions, a mistrust of the identity of individuals and organizations posting materials to social media, crowdsourced reviewing applications, and other sites, and an inability to take forward applications such as internet polling and voting.

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