Beyond bitcoin: an early overview on smart contracts

The technology underpinning Bitcoin—the blockchain—is acknowledged to offer security, stability and efficiency to online transactions. After a brief introduction to Bitcoin system, I touch upon the most innovative implementation of blockchain technology: the so-called smart contracts, ie programmable computer protocols that are able to self-enforce the terms therein encoded upon certain triggering conditions. First, I sketch their core functioning and benefits for digital relationships. Secondly, I stress their structural constraints and the issues of regulability fully decentralized blockchains pose. The elements underlined highlight the reasons why the financial and banking sectors represent smart contracts most immediate testing ground. K E Y W O R D S : bitcoin, blockchain, smart contract, contract automation, decentralization I N T R O D U C T I O N It was the beginning of 2009 when the enigmatic figure of Satoshi Nakamoto released Bitcoin, a peer-to-peer software that offers an alternative to traditional e-payments channels. After remaining circumscribed to a handful of computer programmers for a couple of years, Bitcoin has progressively grown in popularity, attracting the interest—and the criticisms—of financial institutions, regulatory * PhD candidate, Dirpolis Institute, Sant’Anna School of Advanced Studies. Email: p.cuccuru@sssup.it 1 See inter alia European Central Bank, ‘Virtual Currency Schemes’ (Report, October 2012) <www.ecb. europa. eu/pub/pdf/other/virtualcurrencyschemes201210en.pdf>; European Central Bank, ‘Virtual Currency Schemes – A Further Analysis’ (Report, February 2015) <www.ecb. europa.eu/pub/pdf/other/virtualcurrencyscheme sen.pdf>; European Banking Authority, ‘Opinion on Virtual Currencies’ (Report, 4 July 2014) <www.eba. europa.eu/documents/10180/657547/EBA-Op-2014-08þOpinionþonþVirtualþCurrencies.pdf>; Bank for International Settlements, ‘Digital Currencies’ (Committee on Payments and Market Infrastructures Report, November 2015) <www.bis. org/cpmi/publ/d137.pdf>; Financial Action Task Force (FATF), ‘Guidance for a Risk-Based Approach: Virtual Currencies’ (Report, June 2015) <www.fatf-gafi.org/media/fatf/documents/re ports/Guidance-RBA-Virtual-Currencies.pdf>; Financial Action Task Force (FATF), ‘Virtual Currencies: Key Definitions and Potential AML/CFT Risks’ (Report, June 2014) <www.fatf-gafi.org/media/fatf/documents/re ports/Virtual-currency-key-definitions-and-potential-aml-cft-risks.pdf>; Bank of England, ‘Innovations in Payment Technologies and the Emergence of Virtual Currencies’ (2014) 54(3) Bank of England Quarterly Bulletin 262 <www.bankofengland. co.uk/publications/Documents/quarterlybulletin/2014/qb14q3.pdf>; Bank of England, ‘The Economics of Digital Currencies’ ibid 276 <www.bankofengland. co.uk/publications/ Documents/quarterlybulletin/2014/qb14q3.pdf>; Goldman Sachs, ‘All About Bitcoin’ Top of Mind (Report, 11 March 2014); Banca d’Italia, ‘Avvertenza sulle cosiddette valute virtuali’ (Report, 30 January 2015) <www. bancaditalia.it/compiti/vigilanza/avvisi-pub/avvertenza-valute-virtuali/AVVERTENZA_VALUTE_VIRTUALI. VC The Author (2017). Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oup.com. 1 International Journal of Law and Information Technology, 2017, 0, 1–17 doi: 10.1093/ijlit/eax003 Article agencies and public opinion. Nowadays, the technology underpinning Bitcoin—the so-called ‘blockchain’—reveals its manifold potentialities for the automation of online relationships. Far from being just a matter for ‘techies’, the blockchain is bound to be a disruptive technology for data storage, digital asset transfers and transactions management, thus potentially replacing central processors and intermediaries with a decentralized computer architecture. I intend to offer an overview—although not exhaustive—on how and to what extent blockchain technology may re-shape online relationships and the execution of online transactions by briefly highlighting functioning, benefits and natural limits of the so-called ‘smart contracts’—ie programmable computer protocols that are able to self-enforce the terms therein encoded upon certain triggering conditions. In particular, I argue that the intrinsic features of the digital environment confine smart contracts to the management of standardized terms and measurable variables. Moreover, if taken in its purest form, the decentralized architecture smart contracts rely on may jeopardize public policy enforcement and contractual and third-party protection. The elements underlined here explain why the financial sector represents the more natural and fertile ground for the development of smart contracts, thus gaining a pivotal role in blockchain innovation. As a point of departure, section ‘Bitcoin, bitcoins, and the blockchain: an overview’ offers a brief introduction to Bitcoin software, thus setting the technical ground for further considerations. Section ‘Beyond bitcoin: smart contracts on the blockchain’ will then specifically focus on smart contracts, sketching their essential structure (section ‘Smart contracts: core functioning’), their main advantages (section ‘Smart contracts: the benefits of decentralization’), and their macroscopic limits (section ‘Smart contracts: main challenges’). Section ‘Smart contracts: financial sector as a testing ground’ elaborates on the highlighted benefits and constraints and stresses the reasons why the financial and banking sectors represent their most immediate testing ground. This pdf>; Banque de France, ‘Les Dangers liés au Développement des Monnaies Virtuelles: l’Exemple du Bitcoin’ (Report, 5 December 2013) <www.banque-france.fr/uploads/tx_bdfgrandesdates/Focus-10-stabilite-financiere. pdf>; Deutsche Bundesbank, (Deutsche BundesBank Annual Report, 2014) 53 <www.bundesbank. de/ Redaktion/EN/Downloads/Publications/Annual_Report/2014_annual_report. pdf? __blob1⁄4publicationFile>. All documents accessed 31 May 2016. 2 For an overview, see The Law Library of the Congress, ‘Regulation of Bitcoin in Selected Jurisdictions’ (Global Legal Research Center Report, January 2014) <www.loc. gov/law/help/bitcoin-survey/regulationof-bitcoin.pdf>; UK Government Office for Science, ‘Distributed Ledger Technology: Beyond Block Chain’ (Report, December 2015) <www.gov. uk/government/uploads/system/uploads/attachment_data/ file/492972/gs-16-1-distributed-ledger-technology.pdf>; UK Treasury, ‘Digital Currencies: Response to the Call of Information’ (Report, March 2015) <www.gov. uk/government/uploads/system/uploads/ attachment_data/file/414040/digital_currencies_response_to_call_for_information_final_changes. pdf>; US Congress, ‘Bitcoin: Questions, Answers, and Analysis of Legal Issues’ (CRS Report, 13 October 2015) <www.fas. org/sgp/crs/misc/R43339.pdf>; Sénat Français, ‘La Régulation a l’ Epreuve de l’Innovation: les Pouvoirs Publics face au Développement des Monnaies Virtuelles’ (Report fn 767, 23 July 2014) <www. senat.fr/rap/r13-767/r13-7671.pdf>. All documents accessed 31 May 2016. 3 The concept of disruptive technology was introduced by Joseph L Bower and Clayton M Christensen, ‘Disrupting Technologies: Catching the Wave’ (1995) 1 Harvard Business Review 43 and developed in Clayton M Christensen, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Harvard Business School Press 1997). As opposed to sustaining technologies, disruptive technologies ‘bring to a market a very different value proposition than had been available previously’ (Christensen, ibid) 10 and ‘typically enable new markets to emerge’ (Christensen, ibid) 14. 2 An early overview on smart contracts