Illegal contracts reality

Smart contracts are likely illegal, but regardless they are reality.

That’s the view of Dr Mark Giancaspro, from Adelaide University Law School. He told the NZILA conference smart contracts, facilitated by blockchain – a giant, decentralised electronic ledger book – and cryptocurrencies, could think algorithmically to execute their own terms.

Smart contracts were written in code that enabled them to verify and execute themselves.

Their “grandfather” was the traditional vending machine. It had a predetermined input, ie money, that enabled transfer of ownership of property, ie the output was a can of soft drink or a bar of chocolate.

Smart contracts use cryptocurrency on the technological platform of blockchain to achieve the desired output instantaneously.

Smart contracts increased efficiency, were quick and self executing, required no intermediaries and had reduced transactional and legal costs. A smart insurance contract could “make rational decisions on whether a claim would be paid”.

There were no “middle men”, like banks or credit providers, and greater transparency and anonymity. A user’s ID was a serial number attached to a digital wallet.

Dr Giancaspro’s example smart contract was a farmer insuring a crop against extreme weather. A contract term would be that insurance was payable if the temperature was more than 36 deg C for seven consecutive days. The contract contained oracles that linked to the Bureau of Meteorology and confirmed whether a seven-day heatwave had occurred. If so, the insured sum was paid automatically in cryptocurrency.

“No claim is necessary and it takes seven seconds,” Dr Giancaspro said. Human involvement and the claim process were eliminated.

He said other potential uses in insurance included data collection and storage, easier fraud detection, automated reinsurance, and greater privacy in asset management.

Challenges, though, were scalability, the logistics of implementation, “we don’t have the infrastructure to support smart contracts yet”, and fear of the unknown. Smart contracts would need willing consumers to push market uptake of cryptocurrencies, and were hampered by legal uncertainty.

Smart contracts challenged basic contractual requirements because of their ability to spawn other contracts. “Was there legal intent? Would a rational human have entered into the same contract? Would an insurer have issued that policy?” Dr Giancaspro queried.

“If you are delegating authority to a computer, who are you contracting with? Can a computer consider the human concept of reasonableness?”

Dr Giancaspro pointed to other potential downsides. In  court, it was impossible to cross examine a computer. “What if an oracle fails? The computer wouldn’t know what to do.”

While there were workforce ramifications, he said insurers and lawyers would always be needed. “No computer can make a judgement as well as we can; there’s no empathy from a computer.”

He asked who was responsible for rogue smart contracts. If a coffee machine was programmed to reorder pods when its supply was getting low, but the coding got corrupted and it ordered 20,000 pods instead of 20, who or what was responsible? The machine, the buyer, the seller, the programmer?

What if a risk was accepted but a smart contract inadvertently altered the premium? “The smart contact made the decision, but you can’t sue it.”

Dr Giancaspro said the law of agency may apply. “Did the insurer delegate authority to the smart contract as an agent that can make decisions on its a behalf? There’s no express agency, but is it implied? We’re stuck in a no man’s land with liability.”

He said giving smart contracts decision-making ability was fraught. “The principal has little or no control over the agent.”

“Is a smart contract defective if it fails? Is there a remedy under consumer law? But can a contract be defective if it’s doing the job it was programmed to do?

“Could a development risk defence be used? Probably not, because we know smart contracts can make decisions we don’t like,” he said.

He told conference delegates not to panic, but to be prepared. “This is not the future, it’s here right now.”

In New Zealand, big companies were petitioning the NZ Government to look at blockchain technology and the Australian Government was investing $5 million to study it.

Dr Giancaspro said he didn’t know whether smart contracts were the future for the insurance industry, but urged delegates to “keep relevant” and become familiar with the vagaries of blockchain and smart contracts.