Blockchain and Smart Contracts: Modern Building Materials for Law
There’s no denying the striking similarity between innovations from the industrial revolution that led to the modern architecture movement and the potential for blockchain-based smart contracts to modernize legal agreements. These parallels, like crypto itself, find much of their basis in Austrian economic concepts like F.A. Hayek’s “three paradigms of spontaneous and emergent order in society:” Law, Language, and Money.
The Innovation of Blockchain
Of the “three paradigms” described by Hayek, this technology has radically transformed the concept of money, freeing it from an ancient marriage with sovereign-military enforcement and allowing it to exist on its own without third-party control. Blockchain technology has the potential to do the same for the paradigm of law, enabling stronger contractual agreements that more effectively benefit individuals. The foundational paradigm for both of these, language (whether code-based or human-based), essentially remains open-source, but not free from consequence.
Most current blockchain applications are oriented toward financial use cases, and that is to be expected since earlier iterations of the internet did not have a native monetary system. This combined with the status quo of banking meant that the paradigm of money has not been updated for at least hundreds of years. Financial technology builders are essentially making up for lost time with the internet’s role in commerce, and are democratizing many of the tools used by Wall Street in the process.
However, it will soon be necessary to expand this technology into one of the other paradigms to enshrine its benefit to humanity. With precise application, this technology can be used to breathe new life into law, but efforts must be oriented correctly to update the parameters of something so ancient and resistant to change.
Axioms & Innovations of the Modernists
In the late 19th century, the Industrial Revolution had matured enough for experimentation with the new types of materials it mass-produced. We are living through a similar paradigm shift that will result in substantial changes to mechanisms of human interaction that have effectively remained the same for hundreds of years. As the modern innovations of the Industrial Revolution were integrated, modernists who strove to maximize the potential of this new technology developed their philosophies around several core axioms:
New Materials
Around the beginning of the 20th century, available building materials expanded from brick, stone, and wood into mass-produced glass, steel, reinforced concrete, and cast iron. These new materials were stronger by an order of magnitude and able to be produced at scale more easily thanks to the new economics of the Industrial Revolution.
New Engineering
Engineering methods evolved to employ these new materials in novel ways, allowing for the construction of buildings that were no longer dependent on thick, load-bearing walls to stand up. This increased stress tolerance combined with the need for less material led to completely new structural applications such as railroads, glass-clad shopping arcades, suspension bridges, and eventually the modern skyscraper.
Form Follows Function
The two preceding axioms freed architects from historical styles and forms, and allowed them to build in a way that used new materials and engineering to align a building’s appearance with its core function. The reason many buildings from the modernists are so strikingly different is because they removed unnecessary elements and reduced designs down to their most basic forms. Where modernists differed was in their integration, interpretation, and design of a building’s true purpose.
Comfort/Usability
Modernists used this new freedom to experiment with how humans connect with their environment and with each other, expanding the spectrum of discourse on ideal living conditions in the process. For example, architects like Frank Lloyd Wright championed a method called organic architecture that harnessed the multidimensional effect of different planes of existence, which in theory led to better harmony by occupants in the context of a room’s intended use. Through this method, he sought to maximize humanity’s relationship with nature and oneself.
Social Changes
Mass-produced materials that enabled more effective uses of space supported public initiatives like affordable housing, workplaces, and public spaces. Some architects took this to an extreme, like Le Courbousier’s misguided proposal to improve on Paris by razing it and rebuilding it as a brutalist housing bloc. While architecture can help, well-intentioned experiments like Pruitt-Igoe underscored the lesson that architecture alone cannot solve social problems.
Where Competence Meets Vision: A Recipe for a New Movement
The genesis of the modernist movement was at its core a recipe that required two ingredients: Classical Training and Innovative Creativity. Before the modernist movement, architecture had essentially perfected the principles that led it through thousands of years and countless civilizations, yet the basis for this was that materials and engineering methods had remained essentially unchanged.
The first architects to adopt the designation “modernist” were masters of their classical training, but believed things could be done better. They recognized that these new materials, technology, and engineering could push the boundaries of what could be built.
The Value of Architecture, Blockchain, and the Law
Industrialization was as much a revolution for architecture as the blockchain revolution will be for contracts. The task at hand is how to apply these lessons from architectural modernism to contractual relationships, bearing in mind that this technology is not a “silver bullet.”
Architecture
As one of the oldest sciences and oldest professions, architecture is a fixed contemporary to the lifecycle of civilization itself. Fundamentally, architecture provides reliable structures for inhabitants to create value for themselves and their community for a reliably certain period of time. Civilization arose out of a sense of community best supported by structures that take into account the needs of productive members of society that help them live well and become the best versions of themselves.
Blockchain
At its core, blockchain technology has value because it provides democratized access, contribution, and control of reliably secure data. With Bitcoin, blockchain technology allowed us to update the paradigm of money, divorcing it from military enforcement and marrying it to universal mathematical principles in a medium known as cryptocurrency. Having achieved this monumental victory with the paradigm of money, which allows anonymous parties to reliably transact with one another, many have asked why we need this other paradigm, “Law.”
Law
Blockchain provides immutability, transparency, and reliable automation for logic-based commands. Although this is a powerful update to existing systems, law provides reliability and institutional power to the more subjective and nebulous paradigm of human language and shared concepts of “fairness.” As much as it would simplify things to make all agreements logic-based, like code systems, the truth is that humanity requires a great deal of subjectivity and nuance to achieve fair results.
Unfortunately, we have come to call logic-based blockchain modules “smart contracts” even though they are not true “contracts” at all. True contracts are systems of law, which require linguistic definitions and analyses that can’t be accounted for in simple “if x then y” systems. Given how difficult it is to assign a definition to “fairness” or the ever-changing concept of human rights, nuance is still required for society to function.
The Concept of Contracts
If contracts are the houses we’ve built for our agreements with each other, blockchain components are stronger materials because they use immutable, permissionless, math-based logic rather than subjective human language. Ideally this should decrease the amount of uncertainty in agreements and the cost it takes to reach a contractual consensus. In terms of systems architecture, these concepts can be understood with the following statements:
- Like a blockchain, a contract is a closed system representing a relationship between parties. Contracts are based on human language rather than code, and while both are oriented toward an objective outcome, in legal contracts the best scenario is the middle-ground that most fairly accommodates the goals of all parties;
- Law provides reliable context to the more subjective aspects of an agreement, and can apply this system to situations or parties outside of the original agreement (including creditors, beneficiaries, human rights, equity, etc.);
- Like architecture, legal contracts provide a reliable structure for parties to derive mutual value from a relationship for a specific, well-defined period of time.
Traditional Contract Modules
Traditionally, contracts use different types of modules to be more effective and ensure the terms of the agreement are being met. Examples of these types of modules include:
Escrow Accounts — Ensure liquid assets remain safe for the ultimate rightful owner pending the outcome of a transaction or case.
Loan Agreements — Used to record legal interests in assets being loaned and rights to the value of assets, plus interest earned by the lender.
Trust Accounts — Allow separation of management from ownership of assets. Management control is in the hands of a trusted fiduciary (“trustee”) bound by legally-enforceable duties to maintain the account’s value in the best interest of the owners (“beneficiaries”).
Smart Contract Modules
If connected to a contract and its parties through digital signatures, the previous examples could be crafted as “smart” modules in the following ways:
Escrow Accounts — Digital assets could be automatically added to a liquid-staking platform in order to earn rewards and grow nearly risk-free during the escrow period.
Loan Agreements — Defaults could be resolved automatically through event-based logic, with creditors secured by smart contract automatically paid first (as was the case in the Celsius bankruptcy).
Trust Accounts — Assets of a DAO could be entrusted to a publicly-known fiduciary custodian, while members could retain pseudo-anonymity and guide the fiduciary’s decisions through democratic on-chain voting using their membership tokens.
Lifecycle Considerations for Smart Contracts and Proof-of-Stake Blockchains
Proof-of-Stake blockchains like Ethereum provide fertile ground for the potential improvements to contract modules described above. As the first major example of a platform for smart contracts, Ethereum applies the reliability and immutability of blockchain systems to flexible logic-based systems. Ethereum also provides users with reliable token-economics and strong stewardship controls to incentivize long-term presence and value development on the network.
The “Contract Lifecycle” is a way of understanding the natural progression of a contractual relationship, and is the inverse of the Kübler-Ross “Five Stages of Grief.”
- The first stage, “Acceptance,” is the initiation of the relationship and when the contract has been executed by all parties.
- It is followed by “Depression,” when the contract does not accurately reflect the relationship.
- The third stage, “Bargaining,” is when passive acceptance is not working and the parties have to come back to the drawing board to save the relationship. Note: If a new understanding is not reached here, it is unlikely that the relationship will recover.
- The final two stages, “Anger” and “Denial,” are what happens when the third stage doesn’t work, and parties are bound by terms they don’t agree with until the relationship is terminated by nonperformance and/or by incurring a significant penalty. Needless to say, it is in the parties’ best interest to anticipate when a contractual relationship should naturally come to an end.
Blockchain developers can use this framework to anticipate the lifecycle of the types of relationships their platforms and applications were meant to foster. In the context of platforms like exchanges, builders should anticipate different types of assets and the need for flexibility as the regulatory environment changes over time. In the case of more nuanced solutions like modules and dApps, builders will need to consider the types of relationships more explicitly. For example, in the case of RWAs (“Real-World Assets”), tailored timelines for contractual relationships will be more popular for legal contracts than standard platform transactions.
Conclusion
Solution-mapping with professionals like lawyers and insurance agents will allow for greater efficiency and enable more standardized processes. It is this type of orientation that will enable builders and professionals to work together to develop the modernist era of law. Above all, builders and professionals alike should remember that a smart contract alone does not make a better contract nor a perfect relationship, but it can help us do things better. With careful application, blockchain-based contract modules can improve the real-world utility of the blockchain industry’s products and the legal system itself.
If you enjoyed this article, you can hear more of my thoughts on this subject in the talk I gave at the 2023 Nebular Summit Conference in Paris:
