Distributed Ledger Technology and the Future of Life As We Know It

From time to time, some of my good friends whom I have known for a while guest post on my blog.   I am en route to Italy and Trace Schmeltz gave me something interesting to post.  He is an attorney with Barnes and Thornburg.

If you don’t know Trace, he helped out James Koutoulas tremendously when Jon Corzine stole money from his clients at MF Global.  Trace is an expert on financial regulatory law.  He has practiced in Chicago for a long time.  He’s working with the state of Illinois to make sure crypto regulation is correct.

Here is his post.  Given all the hype on crypto currency and blockchain, I thought it was timely.  Especially because I ripped into ICO’s yesterday.

Take it away Trace:

 

Distributed ledger technology or, as it is commonly called, the “blockchain,” is essentially an account book that is maintained on an unconnected network of computers around the world, accessible to multiple users at once, that stores unalterable data.  It can be programmed to accept verified data and take a specified action in response to someone else’s action.  Because it is encrypted, it is very difficult to attack or corrupt.  In other words, the blockchain is a trusted intermediary that can keep track of everything you exchange with someone else.  It just may be the future of life as we know it.  But, for those of you hoping for a more utopian future, it is still likely to include lawyers.

When you think about it, even though the internet has revolutionized commerce, many people still prefer to shop at a physical store because they do not trust that they will get what they want without getting scammed.  Also, people want to do business with companies they believe will be there in the future if they have a problem, so they can go back for a solution.  Imagine, for example, that you really want to buy your produce fresh from a small, organic, farm in Iowa—but you don’t, because you won’t send the farmer money until he ships your produce and he won’t ship your produce until he knows you have the money.  And, if you ever have a problem, you won’t necessarily have a person who can provide a solution.

Enter the blockchain.  With a form of blockchain commonly referred to as “smart contracts,” the farmer can verify that you have money available.  Once he verifies that he has shipped your produce (by entering the FedEx code into a verifying program, called an oracle, for example), the blockchain will release money to him.  The blockchain can even be programmed to set aside a certain amount of each transaction to provide a remedy in the event something goes wrong—like if you get a bad apple.  Or, the blockchain could be programmed to verify in advance that the farmer has adequate insurance to correct an even more significant problem, like ptomaine poisoning.

Distributed ledger technology could lessen the need for certain central counter-parties.  For example, if you want to rent a car, the distributed ledger could allow you to locate a car near you and unlock it based on your verification.  With the ability to immediately verify both customer and provider, car share programs that are only nascent now could replace the large-scale rental car companies—at least outside of airports.  Certainly, there will remain a need for big-box stores that aggregate product that consumers need immediately (think Walmart, Walgreens, or big-box grocers), but the blockchain, and smart contracts in particular, could radically enhance individuals’ ability to monetize their own assets or cooperate in a “sharing economy” with one another.

Of course, as with any innovation, this technology will pose new potential issues.  Programmers who create and roll-out ledgers for others to use may want to consider setting up appropriate legal entities to protect themselves from personal liability if anything goes wrong.  A person executing a transaction on the blockchain will want to be sure he or she fully understands the terms and conditions of the transaction, as automation likely will produce a one-size fits all implementation.  Anyone negotiating a first-time transaction will want to clearly document her intent, as well, as future transactions could be expected to follow the same model.

Furthermore, most distributed ledger technology is intended to run independently, without caretakers or a host.  This is known as a decentralized autonomous organization, or a “DAO.”  Because of its autonomy, a person seeking to process her business transactions on a DAO may want to consider adequate protection in the event the blockchain fails.  Indeed, in the event the blockchain verifies a transaction improperly—perhaps because of fraud, human error in entering data, or the malfunction of an oracle designed to obtain external information (like the insurance oracle described above)—it seems highly unlikely that the DAO will be subject to a lawsuit, much less have sufficient resources to remedy the harm.

In effect, distributed ledger technology is likely to give the internet the trust factor that it needs to provide a revolutionary boost to individual innovation.  What comes next is what we make of it—entrepreneurs need to innovate, consumers and business people need to negotiate clear terms, and parties to any transaction executed on the blockchain need to ensure their intent is clearly documented.  And, while we leave the future to the dreamers, we lawyers are here to lend a hand.

 

  • Seph

    … and Ronald Coase nods in approval.
    Trace, thank you for the post.

    • Trace Schmeltz

      You are welcome!!

  • Andrew Page

    I enjoyed this article, thank you Trace.

    There are a number of projects taking a deep dive into engineering next-generation, smart contract enabled agreements with relatively lightweight additional protections via arbitration or terms for handling edge cases agreed upon by the parties entering the agreement. One project that I have found really interesting lately is Internet of Agreements / Mattereum.

    One quick note. I find this misleading: “Because it is encrypted, it is very difficult to attack or corrupt.” I think you’re trying to say that a proof-of-work consensus algorithm, which involves grabbing random slices of a dataset and hashing them together, makes corrupting on-chain data very expensive. This is a great point!

    But that is not encryption. Also, on Bitcoin and Ethereum and similar protocols, every transaction is public, and all chain state including full state of every smart contract is public. So it is dangerous to lead people to believe it’s safe to put any private or protected data into those transactions based on the assumption it’s encrypted. There are promising advances being made into making on-chain data private, but as of Sep 2017 this is bleeding edge, experimental work that is not yet safe for high-value applications.

    Here’s Zcash’s overview of their cryptographic method for verifying a transaction on a public chain without revealing transaction details to the verifying node: https://z.cash/technology/zksnarks.html

    Here’s an example of this type of proof being verified on Ethereum for the first time as of 6 days ago: https://steemit.com/ethereum/@joshbreslauer/ethereum-metropolis-testnet-verified-a-zcash-transaction

    • Trace Schmeltz

      Thank you for your comments, Andrew! You are right, I short-formed proof-of-work consensus in a way that is less than clear. Thank you for clarifying and providing examples.