Blockchain and Smart Contracts: Impact on the Legal Industry

Distributed ledger technology (DLT) is here and its impact on the legal industry cannot be ignored. Not only is the introduction of this technology causing regulatory modification, but it is also disrupting the traditional flow of how law firms interact with clients. At the moment the most familiar form of DLT is blockchain. Blockchain is modifying how data is stored and exchanged during transactions; it is changing the scope of how critical deals are processed –this is a critical evolution for law firms who often act as intermediaries for their clients. 

What is blockchain? 

At its bare bones, blockchain is a type of technology that tracks and keeps a database of transactions between participating parties – the logs of which can be shared on private or public networks. As explained in an article by McKinsey & Company, blockchain empowers the ‘permanent, immutable, and transparent recording of data and transactions’ making it possible to trade valuable property, whether tangible or intangible. 

Its transparency lies in the way data is stored within a blockchain. Data is stored in “blocks” that when accessed or altered, create a new block of data that is “chained” together, creating an interlinked consecutive record of events and transactions that are encrypted. As new blocks do not override older ones, these chained data sets create a ‘perfect audit history’ (McKinsey & Company) that is accessible to all parties with access to the blockchain – a highly cost-effective and attractive feature of the technology. All records are digitised and can be tracked by the companies involved, adding yet another layer of accessibility and time/cost-effectiveness that is making waves across the market. 

Blockchain is most frequently associated with Bitcoin, seeing as it was the first cryptocurrency to successfully use the technology in 2009. This has since expanded to other areas of application. Technology writer, Nick Barney, logistic companies, government central banks and the global financial community as testing grounds for the DLT as a ‘foundation for currency exchange’. Barney further mentions that companies and other organizations also engage in using blockchain ‘as a secure and cost-effective way’ to not only manage distributed databases but also maintain the records for any digital transactions that may take place. This is pivotal. By these global organisations engaging with this technology, blockchain has gained and upheld a reputation for being a secure way to track and share data between a multitude of commercial entities. 

Another interesting feature of blockchain that directly impacts the legal industry is its ability to support smart contracts. Smart contracts allow buyers and sellers to trade without the necessity of an overlooking bank or other financial intermediaries (which may sometimes be law firms). Not only could this potentially encourage users to have more direct control over their money (and as a result more responsibility/liability), but it may also cut out the need for a middleman, causing a real shift in the legal and financial industry. 

But what are smart contracts? 

In an article published by the World Economic Forum, Jerome Desbonnet and Oded Vanunu describe smart contracts as ‘self-executing agreements embedded in blockchain technology’. They are only activated once a series of actions have been completed in the transaction process. 

In the legal industry, the use of smart contracts makes way for a more efficient process of operations, whether that be whittling down the time it takes to sort through documents or enacting client agreements that are not necessarily legal but still take up time and money. In discussing ‘Smart vs. Traditional Contracts for Legal & Courts’, Riley Kooh describes five ways in which smart contracts can be utilised in law:

1. Automated contract execution 

As the name suggests, smart contracts can be used to initiate and complete agreements set out based on predetermined conditions. Kooh uses the example of the distribution of royalties based on the number of interactions (or any other prerequisite). 

2. Asset tokenisation 

Tokenisation is defined as the process of creating a digital representation of a real thing. It can also be used to protect sensitive information and/or break down large datasets. Smart contracts can tokenise assets, therefore allowing the asset to be recognisable in blockchain and as a result, making the transfer process of said asset traceable. 

3. Digital notary services 

Kooh states that by functioning as a digital notary, smart contracts can ‘elevate the integrity of a legal document’ by having them accessible and timestamped in blockchain. 

4. Decentralized escrow services 

Where a transaction may need an intermediary, smart contracts can take the place of the middleman and release funds immediately upon conditions being met, which may arguably mitigate the risk of fraudulent activities. 

5. Dispute resolution 

Kooh argues here that ‘transparency and immutability’ are inherent in blockchain and by proxy, smart contracts can become a great tool to solve disputes between parties. Blockchain creates ‘indisputable’ records of the transactions/contracts that have been made between parties. 

However, the drawback to smart contracts and as a result blockchain, is that it is only as good as the code that has been written into the system. Once set in motion smart contracts cannot be modified and therefore lack the discretion necessary to recognise a problem, and then implement a solution, should things go awry (‘In Code we trust? Trustlessness and smart contracts’). Should a smart contract fail, for any reason whatsoever, it may be very difficult to assign liability and – although developing – there is little governance or regulation surrounding the use of smart contracts or blockchain, which further impacts lawyers that may have clients affected by the kinks in contracting with blockchain.  

This is just one of the many concerns that blockchain has raised in the legal industry. Other worries have been outlined by the likes of legal author Nick Oberheiden in the article ‘How Blockchain Impacts the Legal Profession’, including threatening human proof of service, litigation and settlement process potentially moving onto a blockchain server or accepting legal fees in cryptocurrency and how it will be processed – all of which threaten the way the industry operates currently. 

While I would not say the legal industry is under threat (just yet), blockchain will definitely be making some changes to how lawyers interact with clients in the future.