Think smart about contracts
It has been more than 20 years since American computer scientist Nick Szabo first proposed the concept of digitised agreements made between individuals and organisations called smart contracts. We are only just beginning to realise the power of this crucial innovation and to develop the infrastructure and tools to truly put his concept into practice at scale. The ability to standardise and componentise contracts and business processes globally will drive incredible growth in productivity in global commerce, unlocking new opportunities and creating new industries.
The first implementations of smart contracts have been fairly basic. They can be thought of like one of Szabo’s early examples of a vending machine: you select a product, input money and receive your desired product.
This transaction represents a simple smart contract that allows you to purchase goods from a machine without needing an individual to broker the transaction. Smart contracts, however, will become incredibly more powerful, particularly as we have advanced technology that allows contracts to reference data stored in globalised databases called blockchains.
We are witnessing a steady evolution as the technology and associated practices mature. It began with relatively simple and straightforward contracts in the form of the creation of digital money, often referred to as cryptocurrencies.
The key is to look past the wild, fundraising schemes that represented the cryptocurrency bubble, and recognise the innovation that is represented by the creation of user-friendly, digitised currencies, particularly those that represent well-regulated, digitised versions of traditional paper fiat dollars.
Digital currencies represent a crucial building block in the development of a smart contract-powered future. They will be essential when it comes to enabling payment and incentive structures to be built directly into smart contracts.
This will allow dividends on investments, automated settlements between parties, funds to be held in escrow, royalties and other payment and incentive structures that will be crucial to making smart contracts valuable. Digital currencies will unlock novel uses and open many individuals’ eyes to the possibilities, but, they are only the beginning.
We are starting to see a development of understanding of the real underlying power of smart contracts in the form of digital assets. These digitised structures allow us to create new representations of ownership and incentive structures.
As Szabo described, smart contracts will enable the creation of new kinds of synthetic assets. “These new securities are formed by combining securities [such as bonds] and derivatives [options and futures] in a wide variety of ways. Very complex term structures for payments can now be built into standardised contracts and traded with low transaction costs.”
It is important to recognise that each of these innovations are an important step in a much bigger future. There are still significant challenges to overcome in order to move this industry from the shadowy world of anarchists, hoping to reinvent the present world order, into the bright future, where the challenges of regulatory compliance can be drastically reduced and regulators work closer in partnership with innovators to drive a more prosperous, fair and free future.
There is tremendous potential to unlock the power of digital identities to give us power and granular control over access to our data and the nature of our digital selves. Rather than suffering under the age of data protection, where our data is increasingly hoarded in ways that make it a ripe target for bad actors, we can unlock the power of being able to isolate and control our details, so that only we control the full picture.
We will unlock the ability to selectively share particular profiles about ourselves; whether it is our address and wi-fi code with a friend or family member, or our anonymised credit history, in order to obtain a loan. This will create powerful, new advancements in the potential for digitising contracts.
Take a simple example, such as a rental agreement between a landlord and tenant. This is a perfect case where clauses of the contract can be automated and componentised. A common challenge that Bermudians face is the notion of putting down a deposit and the associated risk that a landlord will try to keep it at the end of the contract, for spurious reasons. Ideally, it would be best to have a neutral third party that could hold the deposit and release it only at the agreement of both parties.
The challenge is that this kind of a process today is expensive and complicated. An opportunity is the option to codify this type of deposit safekeeping or escrow mechanism into an automated contract.
That process can be componentised so that it represents only one clause of a larger possible agreement, which can be reused across many similar cases that exist, in the larger scope, of global trade. The challenge is that this process will remain expensive, until we can rely upon a form of digital fiat currency that makes putting the deposit aside in an automated contract cheap and easy.
It then becomes possible that tenants could put aside a digitised asset as a deposit. Rather than having to put aside a month’s rent as deposit that a landlord can invest or earn interest on, it would be possible for the tenant to continue earning income on the asset they put aside as a deposit. It need not be a creative investment scheme, and could more likely be fractional ownership of a rental income property that helps a renter to accrue wealth to eventually be able to own their own home, outright.
Once we have digitised deposit mechanisms, it becomes conceivable that multiple portions of existing agreements can be automated. It could be that payments themselves between the landlord and tenant are automated such that their payment history becomes readily traceable. Any stamp duties, taxes and insurance could also be automatically paid. All of which provide provenance or a detailed history of reliable payments that the tenant can reference for future agreements.
It becomes conceivable that a digitised rental agreement could be expanded to include certification of the state of the property in terms of photos and inventory lists at the start and end of a contract, from the perspective of both parties.
Any disputes that arise that are not able to be amicably resolved between parties can be raised to an independent arbitrator, who can have reliable access to all of the underlying data that satisfies the promise of the potential of smart contracts to improve their privity, observability, auditability and enforceability.
A key consideration is that this level of automation is not limited to just rental agreements, but is applicable to a wide range of trade and business agreements, as well as processes. A critical factor will be putting the right building blocks in place to make this possible.
Digitising traditional paper money in a way that allows it to be shared among parties, and run as part of contracts, is a necessary first step. A key secondary element will be providing confidence around the ability to rely on third-party sources of data and code, that can help to power these forms of agreements. Finally, legal protections and processes will need to be wrapped around these contracts to ensure enforceability in the real world.
These are much of the considerations that are top of mind when it comes to developing a road map of where this technology can go, and what kind of opportunities there are for Bermuda in helping to facilitate the development of it. They are critical to discovering how we can pursue the kinds of applications that clearly fit the nature of our island, as a jurisdiction.
If Bermuda can play a role in driving the standardisation and componentisation of contracts and business processes globally, we will reap the benefits of increased productivity while unlocking new opportunities, creating new industries and ultimately driving prosperity for Bermudians.
• Denis Pitcher is a Bermudian tech entrepreneur with an interest in exploring the potential of blockchain and distributed ledger technologies for Bermuda. He is a fintech consultant to the Bermuda Government’s fintech Business Unit as well as a tech cofounder and chief architect of resQwest.com, a global tourism technology solutions provider. He can be reached at firstname.lastname@example.org
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