Wharton’s Kevin Werbach and Nicolas Cornell discuss their research on smart contracts.
‘Smart’ contracts on the blockchain are generating a lot of interest because of their innovative nature and potential to substantially boost efficiency in many areas of law and business. But these contracts — digital agreements that automatically fulfill themselves — come with serious limitations as well.
Kevin Werbach and Nicolas (Nico) Cornell, both Wharton professors of legal studies and business ethics, recently spoke with [email protected] about their paper on smart contracts, “Contracts Ex Machina,” which literally means ‘contracts from the machine’ — a nod to Greek tragedy’s deus ex machina plot device. The question they tackled was this: Could smart contracts one day replace contract law?
An edited transcript of the conversation follows.
[email protected]: What are smart contracts, and can you give us examples of how they work?
Kevin Werbach: A smart contract is an agreement in digital form that is self-executing and self-enforcing. Let’s say that I want to bet Nico about who is going to win the Super Bowl. I think the Eagles are going to win the Super Bowl, and so we bet $100. Now let’s just assume for a moment that it is a legal transaction — we are in Las Vegas or someplace where you can make a sports bet. So the end of the season comes along, the Eagles do not win the Super Bowl because, of course, they never do, and Nico comes to me and says, “Okay, where is my hundred dollars?” If it’s a normal contract, I might say, “Well, I was just kidding,” or “Well, I actually don’t have the money.” He might have to go into court to sue me to enforce the contract.
With a smart contract, we could do that same agreement digitally, so that the moment the Super Bowl happens and it’s clear who won, the contract is automatically enforced. The money gets transferred. There is no party — neither of us, nor even someone else in the middle, an intermediary — that makes the decision. The contract is just automatically enforced. And it can be applied, this approach of smart contracts, to any kind of agreement. Many things are contracts — the rental agreement that you might use for a home, your employment agreement, your business transactions in a company, purchases. Smart contracts, in theory, could take any of those and make them automatically enforceable.
[email protected]: Tell us how else they are different from, say, online agreements that we agree to when we sign up for Facebook or Linkedin, or when we set up autopay for our monthly bills?
Werbach: In the paper, we talk about four different categories of increasingly decentralized and increasingly automated contracts. The first is what you described — what we would call just an electronic agreement. So you go to any website that you sign up for, you click a button, and there is a link there. And you can see, typically, an incredibly long and detailed contract that no one ever reads. But that is a human-readable contract. It’s the same contract you could get on paper. It just happens to be on a screen.
One step from that is what Harry Surden, who’s a law professor at [the University of Colorado at Boulder], calls a “data-oriented contract.” So let us now put the terms of the contract in machine-readable form, which limits what we can do in that contract, but we can do it in ways that computers can at least understand what it means to say “a hundred dollars,” or what it means to say, “purchase this share of stock,” or something. The next step is what Surden calls a “computable contract.” So now we are at the point where the machines can, to some extent, process and enforce the contract. But there is still the fallback of the legal system if something goes wrong.
A smart contract, in theory at least, takes away the legal system entirely. Now there is nothing but that digital agreement. That is the entirety of the relationship, and everything from the negotiating of the agreement, all the way to the full enforcement and clearing of the agreement, happens digitally.
[email protected]: Why are people excited about smart contracts? What are the benefits?
Nicolas Cornell: There are two primary reasons why people are excited. The first is about gains in efficiency. Any time you can automate a process and remove the human element, there is the possibility of transformative increases in efficiency and reliability. Just think about what computerization has done for other areas of our lives.
Second, people are also excited about the possibility of removing human institutions, and in particular government institutions, from an important function that they currently play. Right now, contracts depend on a legal system administered by a government. This requires trust in a coercive and fallible authority. So for the same reason that bitcoin enthusiasts are excited about the prospect of currency without a government, smart contract enthusiasts are excited about the prospect of contracts without a government-run legal system.
“The reality is, even though we think machines can render contracts effectively, there are lots of situations where they cannot.”–Kevin Werbach
[email protected]: Are smart contracts legally enforceable, and how can one get legal relief after the contract is automatically executed?
Cornell: We think the answer is yes, that smart contracts are legally enforceable. There is no reason to think one cannot make a contract in computer code or electronically. We have been doing that for quite a long time now. There is a little bit of a complication because we normally think of contracts as agreements that are intended to be legally enforceable, and smart contracts are, by their nature, intended not to be legally enforced. But we still think that they are changing the rights and obligations between the parties. And that is the important thing for something to be a contract in the legal sense.
How can we get relief afterwards? There are a bunch of legal mechanisms to reverse transactions or disgorge wrongfully obtained funds, but these are legally quite different structurally and potentially more difficult. So by reversing who stands as plaintiff and who is trying to legally change the situation, we really do end up shifting the complexion of the legal dispute that might arise.
Werbach: This is a good example of partly what got us, as legal scholars and professors, interested in this. Smart contracts are a technical innovation, and the enthusiasts, a lot of the engineers, say, “Well, this has nothing to do with the legal system and legal enforcement.” The reality is that it actually forces us to take a closer look at just what the legal system does. And it creates all these kinds of fascinating new issues.
[email protected]: In your paper, you list some limitations of smart contracts. What are they?
Werbach: If you read a lot of the breathless pronouncements, smart contracts have basically solved the problem of contract law. We no longer need the legal system or government, as Nico talked about. We don’t have any uncertainty anymore, because contracts are automatically enforced. Well it is, of course, not that simple.
There are two