A Canadian digital currency exchange (QuadrigaCX) reported recently that a malfunction in a smart contract is responsible for a $14 million dollar loss of the cryptocurrency ether. You can read more about the company’s technical explanation here, but the upshot is that a software upgrade performed by the company had an error in the code that prevented the smart contract from properly processing incoming amounts of the cryptocurrency Ether. The error was not caught for a few days, and during that time, Ether sent to the company’s exchange was “trapped” in the smart contract. Based on Ether’s current price, the amount of “trapped” Ether is valued at approximately $14 million. It may go without saying, but the risk of currency becoming trapped inside a contract—and therefore rendered unusable, even though it technically remains in the possession of the owner—is not a risk traditionally associated with commercial transactions. As the QuadrigaCX situation illustrates, smart contracts introduce novel risks that may increase exposure to financial losses. In this post, we suggest that these risks and losses may be mitigated through proper indemnification; however, a review of existing insurance policies should be undertaken to determine if they provide coverage or, alternatively, if additional coverage should be procured.
This is the fifth and final in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. We have discussed the enforceability of blockchain-based smart contracts under ESIGN and UETA and a few promising smart contract applications. We will now examine the use of blockchain-based smart contracts for microgrids. You can read the full article here.
Within the energy industry, blockchain-based smart contracts can accelerate the development of smart meters, as we discussed earlier. However, they can also help accelerate the development of microgrids. Blockchain-based smart contracts can provide the tool to give both utilities and customers the levels of efficiency and effectiveness that both strive for, while delivering both the consumer protections and individual choice that stakeholders often advocate.
This is the forth in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. We previously discussed the enforceability of blockchain-based smart contracts under ESIGN and UETA and the application of blockchain-based smart contracts for simple insurance contracts and parametric insurance. We will now examine the use of blockchain-based smart contracts in the energy industry, specifically for smart meters. You can read the full article here.
The energy industry is actively examining new models and mechanisms for delivering service to customers. Likewise, customers themselves are looking for new ways to purchase energy and to understand the origins of the energy they purchase. Blockchain-based smart contracts can provide a new, more secure basis for smart meters and, in fact, can take advantage of blockchain’s currency foundations to automate payments as well.
This is the third in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. We previously discussed the enforceability of blockchain-based smart contracts under ESIGN and UETA and the application of blockchain-based smart contracts for simple insurance contracts. We will now examine the use of blockchain-based smart contracts for parametric insurance. You can read the full article here.
As discussed in our last post, life insurance and final expense insurance are good examples of simple “if-then” arrangements that can be digitized into blockchain-based smart contracts in relatively straightforward ways. But could other types of insurance that are currently reliant on more subjective factors be restructured into products with more firmly defined parameters, enabling their digitization and administration through blockchain’s transparent processes? Parametric insurance policies offer such potential. By pairing parametric insurance with blockchain-based smart contracts, insurers can reinvent the manner in which classes of insurance are offered.
This is the second in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. We previously discussed the enforceability of blockchain-based smart contracts under ESIGN and UETA and will now look at the application of blockchain-based smart contracts for simple insurance contracts. You can read the full article here.
Even though basic insurance contracts can often be boiled down to an agreement to make payment upon the occurrence of a discrete event, administration can quickly become complex. Claims adjusters are needed to assess a claim and its validity and disagreements can arise if parties later disagree about the interpretation of the terms or relied on representations outside of the policy. In addition, parties are often mistrustful of one another because of the potential for fraud, abuse, or denial of claims. In either event, insurance companies incur costs administering even the simplest of contracts, and those costs are often passed along to consumers in the form of higher premiums. However, reducing basic insurance contracts to “if-then” statements and digitizing administration would reduce the cost of administering these products and help overcome challenges of trust and transparency.
This is the first in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. First, we will discuss the enforceability of blockchain-based smart contracts followed by four use cases: simple insurance contracts, parametric insurance, smart meters, and microgrids. You can read the full article here.
Smart contracts have the potential to impact a range of industries, and some are even calling 2017 “The Year of Smart Contracts.” Smart contracts can be used not only to automate existing processes, but also to create new industries and reach new markets. By providing a digital platform for coding “if-then” statements, providing a secure and resilient environment for value transactions, and preserving a detailed and immutable transaction history, the blockchain provides an ideal platform for smart contracts.
With companies and industries continuing to explore new blockchain-based smart contract applications, it is important to establish their enforceability.
Numerous questions have already been raised as to whether a contract on the blockchain is binding and enforceable. Vermont, for instance, has made multiple attempts to pass a law that would make blockchain evidence self-authenticating, and has finally succeeded in enacting one. Arizona recently passed a law clarifying that signatures obtained through blockchain technology are valid electronic signatures. We believe that the federal Electronic Signatures in Global and National Commerce Act (“ESIGN”) and state laws modeled on the Uniform Electronic Transaction Act (“UETA”) provide sufficient legal foundation for blockchain-based smart contracts to be enforced under current law.
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.)
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:
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.
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?