Smartifying Blockchains, Legally

Yes, block­chain tech­no­logy can do things which con­ven­tion­al ledgers or registers can­not do. A few days ago I argued that this didn’t mean block­chain should replace tra­di­tion­al ways of record­ing leg­al trans­ac­tions whole­sale. Tra­di­tion­al ways of record­ing leg­al trans­ac­tions embed func­tions which block­chains don’t embed yet. Where the law demands it or wherever else it makes sense we should think about imple­ment­ing them.

Here’s in more detail what I had in mind.

What Blockchains Are Inherently Good At: Evidence and Control

There are two things that block­chain tech­no­logy can do bet­ter than any not­ary, tra­di­tion­al register or piece of writ­ing. They’re related. First, cla­ri­fy with cer­tainty wheth­er a trans­ac­tion has come about and what the con­tent of this trans­ac­tion was. It’s an evid­en­tial func­tion. Second, enable com­pli­ance con­trol or, more pos­it­ively speak­ing, com­pli­ance man­age­ment. This can come into play where trans­ac­tions trig­ger tax oblig­a­tions such as prop­erty tax or stamp duty. It’s a con­trolling function.

The Traditional Legal Approach

These two func­tions are inher­ent in block­chain tech­no­logy, which allows the record­ing of data in a dur­able, immut­able, reli­able, avail­able and trans­par­ent man­ner. Tra­di­tion­ally, leg­al sys­tems, at least those embra­cing free­dom of con­tract, allow leg­al trans­ac­tions to go ahead without ensur­ing these func­tions. That’s because tra­di­tion­ally only impos­ing addi­tion­al, often incon­veni­ent require­ments on the parties involved could ensure these func­tions. In free­dom of con­tract sys­tems, restric­tions like this are only jus­ti­fi­able to pro­tect over­rid­ing interests, usu­ally over­rid­ing pub­lic interests.

Writ­ten form is an example of a rel­at­ively mild, um, form of such a require­ment. Then there is not­ari­al form, the require­ment to have a leg­al trans­ac­tion recor­ded by a not­ary. Anoth­er require­ment is the duty to have the res­ult of a leg­al trans­ac­tion entered in an offi­cial register. Some­times we find more than one of these require­ments imposed at the same time.

Shares in Private Companies

The cor­por­ate space is a good example.

In Singa­pore, the trans­fer of shares in a private com­pany is not effect­ive until the regis­trar has updated the elec­tron­ic register of mem­bers of the com­pany. Regis­ter­ing a share trans­fer requires a prop­er instru­ment of trans­fer; an instru­ment being a writ­ten doc­u­ment, mind. A sale of shares trig­gers stamp duty, and no respect­ive instru­ment is admiss­ible in evid­ence for any pur­pose unless it’s duly stamped.

In Ger­many, the trans­fer of shares in a com­pany with lim­ited liab­il­ity by a share­hold­er requires not­ari­al recording.

There’s no need to go into detail any fur­ther. Suf­fice it to say that a trans­fer of shares in private com­pan­ies isn’t as easy as one-two-three.

Landed Property

Landed prop­erty provides even bet­ter examples.

In Singa­pore, any con­tract for the sale or oth­er dis­pos­i­tion of immov­able prop­erty must be in writ­ing to be enforce­able. For an instru­ment of trans­fer of own­er­ship in registered land to be effect­ive you must enter it in the land titles registry. There are pre­scribed forms for this, which you must use. These instru­ments trig­ger stamp duty, too. And again, only an instru­ment duly stamped is admiss­ible in evidence.

In Ger­many, for a con­tract on the trans­fer of own­er­ship of land to be effect­ive a not­ary must record it. The trans­fer of own­er­ship itself, called declar­a­tion of con­vey­ance (Auflas­sung), is a sep­ar­ate agree­ment. All parties must enter into it before a com­pet­ent agency. This can be a not­ary but also a court at times, among oth­ers. In addi­tion, for the trans­fer of own­er­ship in land to be effect­ive you must register it in the land register.

An agree­ment to trans­fer own­er­ship not recor­ded by a not­ary is void. It becomes val­id, though, if the parties declare con­vey­ance and the trans­fer is registered in the land register. In oth­er words, ful­filling that second form require­ment heals not ful­filling the first form requirement.

Again, there’s no need to go into fur­ther detail. As you can see it isn’t easy to act rashly on a landed prop­erty trans­ac­tion. Also, you really need to know what to do if you want a landed prop­erty trans­ac­tion to be effective.

Spousal Consent

Anoth­er one from Ger­many, often over­looked. A spouse may only agree to dis­pose of his prop­erty as a whole, and of objects of the house­hold too, if the oth­er spouse con­sents.

If one spouse enters into such a con­tract without the con­sent of the oth­er spouse, the con­tract is inef­fect­ive. Unless the oth­er spouse rat­i­fies it. If one spouse enters into a uni­lat­er­al trans­ac­tion without the neces­sary con­sent of the oth­er spouse, the trans­ac­tion is simply inef­fect­ive. It’s a uni­lat­er­al trans­ac­tion, for example, and not a con­tract, if one spouse aban­dons own­er­ship of his prop­erty as a whole.

What Blockchains Are Not Inherently Good At

These are examples of leg­al trans­ac­tions which are sub­ject to restric­tions of private autonomy. Why aren’t we free to trans­fer own­er­ship of our house and our shares in a private com­pany to a friend by hand­shake agree­ment alone? In Ger­many, why must our spouse be okay with it if the house and shares are everything we own? And if we add a few house­hold objects for good measure?

Warning and Advising

There are vari­ous reas­ons why a leg­al trans­ac­tion needs to meet con­di­tions to be val­id and/or enforce­able. A writ­ten form require­ment has evid­en­tial func­tion. So does law which pre­scribes that some­thing is only admiss­ible in evid­ence if stamp duty has been paid. Writ­ten form also emphas­ises that what I’m about to be doing is not as simple as buy­ing a magazine. Hav­ing to com­ply with it reminds me not to rush things. It’s a warn­ing function.

The same applies where law decrees that to be effect­ive a leg­al trans­ac­tion requires not­ari­al record­ing. The notary’s explan­a­tions of what’s hap­pen­ing and what it all means add an advising func­tion to the whole. A not­ary can also ensure com­pli­ance with tax and duty oblig­a­tions, thus ful­filling a con­trolling function.

In fact, hav­ing to involve any spe­cif­ic third party serves the above func­tions com­bined: evid­en­tial, con­trolling, warn­ing and advising. Be it a not­ary, the gov­ern­ment, the mis­sus or the hubby.

Finally, regis­tra­tion require­ments ful­fil evid­en­tial and con­trolling func­tions. Where you need to register a trans­ac­tion for it to be effect­ive in the first place, it serves a warn­ing func­tion too.

Implementation in Blockchains

Of its own accord, block­chain tech­no­logy doesn’t ful­fil warn­ing and advising func­tions. As things devel­op law­makers might con­sider this insuf­fi­cient. This could set back or even render impossible the use of block­chain tech­no­logy for cer­tain leg­al trans­ac­tions. In par­tic­u­lar, trans­ac­tions whose objects are phys­ic­al, because they are under the aegis of lawmakers.

That’s why we should think about how we can load the warn­ing and advising func­tions into the technology.

And although there’s not much that law­makers can do to make observing these func­tions man­dat­ory for trans­ac­tions tak­ing place in cyber­space entirely (because haha) it might make sense to imple­ment them there as well.

How to Do That?

A block­chain is a ledger, a register, a data­base, but in the form of soft­ware. It can con­tain as data any­thing which its paper-based equi­val­ents can con­tain too. Includ­ing code. The dif­fer­ence is that code on paper can’t be run dir­ectly but code on a block­chain can be.

This has been dis­cussed under the term ‘smart con­tract’. It means that you can code all kinds of things onto a block­chain includ­ing warn­ing and advising functions.

The degree to which a func­tion so coded must be ful­filled before a trans­ac­tion can get executed may vary. It’s pos­sible to imple­ment a simple are-you-sure-con­firm-or-can­cel dia­logue, or a detailed guid­ance pro­ced­ure tan­tamount to an after­noon at the notary’s. Or everything in between. Where warn­ing and advis­ory needs are small, simple con­firm-or-can­cel dia­logues, man­dat­ory videos etc. could do the trick. Code can provide for that. Where law or good sense call for more soph­ist­ic­ated effort, code alone may not be enough. Instead, a com­bin­a­tion of code and human involve­ment could imple­ment more strin­gent require­ments as needed. In this case code could con­tain the con­di­tion of a decision maker’s placet as trig­ger for the trans­ac­tion to pro­ceed. In so far, this would mean tak­ing the trans­ac­tion off-chain. Think of that not­ary or the rev­en­ue author­ity or their cyber equi­val­ents. Think of the spouse.

Evolution

Smart con­tracts aren’t secret sauce. The nov­el bit is that today the idea of execut­ing parts of a smart con­tract off the chain is bet­ter accep­ted than before. For a moment in time this ex mach­ina ele­ment had seemed incon­ceiv­able to many pro­ponents of block­chain tech­no­logy. Some coders and oth­er enthu­si­asts had even assumed that one could tran­scribe any leg­al trans­ac­tion into code entirely. And thus admin­is­ter and execute it by code alone. This way, they had believed, block­chain tech­no­logy would obvi­ate the need for third-party involve­ment in leg­al trans­ac­tions, espe­cially that of humans. From the per­spect­ive of jur­ists mind­ful of the dangers of con­cep­tu­al jur­is­pru­dence (Begriff­s­jur­is­pru­denz), that was so 1867. But the events lead­ing to the hard fork after the DAO hack of 2016 has put the ortho­dox right.

By now it’s widely accep­ted that smart con­tracts can con­tain more than self-execut­able code. They may, and per­haps should at times, con­tain a com­bin­a­tion of code and human lan­guage. Smart leg­al con­tracts like this, oth­er than smart con­tract code alone, have the poten­tial to evolve into soph­ist­ic­ated trans­ac­tion tools. Adding warn­ing and advising func­tions to block­chains is only a small, albeit import­ant detail of this evol­u­tion.