Smart Contracts and Decentralized Autonomous Organizations: The Death of Lawyers?

Are you a business owner who dreams of closing a deal without hiring an attorney? When you buy a car from a stranger on craigslist, are you ever sure the person selling the car actually owns the car? Is your fair trade coffee really fair-trade, how do you know where it really came from? Are you a  supporter of Wikileaks and struggling to make a donation due to Wikilieaks being shut out of the payment networks (Paypal, Mastercard, etc)? Do you hate the idea of a few select mega-internet companies using and storing all your personal information?

Smart contracts and decentralized applications promise to remove middleman and reduce friction in all types of property transactions by using self-executing code and the blockchain, decentralized applications can reduce fraud, prevent censorship, and third-party interference .

By turning law into code, and turning that code into smart contracts, and by having those smart contracts combine with the blockchain technology underpinnings of bitcoin, with those few lines of code, programmers will soon be creating decentralized autonomous organizations (DAOs) can operate over a computer network without any human intervention. The need for the hated legal middleman will be greatly reduced (full disclosure: I am a contributor to the CommonAccord project which aims to turn law into code).

IN THE EARLY DAYS AND OUR CURRENT CENTRALIZED INTERNET

At first the Internet was a great equalizing platform. The promise of the early Internet was that the big and powerful would no longer have sole control over the dissemination of information. To some extent this is true today, but most of our Internet traffic is routed and filtered through large centralized entities, such as FaceBook or Google. In some cases, an entire country, such as China, filters the information available to the general public.

To a certain extent this has worked out well for consumers, as Gmail is a more reliable email service than a local provider (do you remember using your crappy unicorn@roadrunner.net account?) and using Dropbox is easier than creating your own cloud server. In China, citizens get a heavy dose of censorship.

The centralization of information on the Internet creates concerns about security, privacy, censorship, and the fragility of having our information stored with a few large entities.

RISE OF A DECENTRALIZED INTERNET

While many in the general public have heard of Bitcoin, an opensource decentralized cryptocurrency, which was created by the mysterious “Satoshi Nakomoto” after the 2008 financial crisis. Bitcoin entered the general public consciousness a few years later after its price shot to over $1000 a coin in a short period of time, it then became a mainstay topic on CNBC, and inspired other cryptocurrencies such as dogecoin and litecoin.

Once, the hype died down and Bitcoin prices crashed back down to the $300 range, many became dismissive of Bitcoin and cryptocurrencies entirely. In fact there is an entire reddit forum dedicated to this /r/Buttcoin. However, it is not the Bitcoin in and of it self that proved to be important, it is the underlying technology powering cryptocurrencies that has become important. The underlying technology/mathematical breakthrough is a public ledger system called the “blockchain.” Bitcoin works by having the entire decentralized network of bitcoin users publicly verify every single transaction via a series of complex math problems. These transactions remain public and traceable, because each transaction constitutes a step in the blockchain.

BLOCKCHAINS MAKE THE DECENTRALIZED INTERNET POSSIBLE

Currently contracts are an exchange of promises written on paper, and with the implicit backing of the legal system, a party releases money to another party if those promises have fulfilled. Smart contracts are essentially a contract that enforces itself. A smart contract is a computer program whose promises are automatically executed.

The original idea for smart contracts was conceived way back in the 1990s by Nicholas Szabo (who is also rumored to be Satoshi Nakomoto the creator of Bitcoin). Szabo provides a primitive example in the vending machine. Where the amount of loss to the user is limited to the cost of a candy bar, and the most likely the cost of paying a dollar for a candy bar outweighs the cost of smashing the glass and stealing a candy bar. Anyone with coins can participate, and the vending machine dispenses change and a candy bar. The lockbox on the vending machine provides sufficient protection against attackers.

Being able to execute entire programs/contracts on a blockchain allows for a “trustless” transaction to be verified solely by the blockchain. Like a vending machine, a trustless transaction allows the party to not care who the other party is on the other side of the transaction, because the code will serve as the law. For example, in a country where the rule-of-law can be arbitrary or where trust is low, then the code can serve as substitute, because money will be released when pre-determined conditions have been met. A trustless contract allows a smaller player to become a trusted party without having access to millions of dollars needed to become trustworthy.

Instead of a vending machine, say an obscure, but real and honest Nigerian prince acquired a domain name that eventually became worth a lot of money and now they want to sell it on the open market. Well due to the notorious proliferation of Nigerian prince email scams, nobody may believe that our prince actually posses this valuable domain name. Our prince could put the domain name on a decentralized exchange, where once a certain price is met on the buyer’s part(and possibly other conditions to sale) and the domain name is released by the prince, then our prince would automatically receive the money. In fact, nobody will care or be required to care that the seller is our Nigerian prince, because he will only be identified by his private key.

THE GOD OF MANY FACES: The Decentralized Autonomous Organization (DAO).

In fact, with smart contracts an entire organization –a Decentralized Autonomous Organization (“DAO”) running on code, could potentially be created and be the sole administrator for a group of shareholders, city, or any other group who agree to abide by a common code, and the DAO would operate based on votes verified by the blockchain. One DAO could be a shareholder in another DAO, in essence the DAO would no longer be serving a human master, but the needs of another algothim.

ENTER THE ETHEREUM PROJECT

Ethereum is the first blockchain platform designed from the ground up to be capable of processing transactions larger than cryptocurrencies and in much faster manner than Bitcoin. In fact Ethereum’s blockchain is designed for the creation of an entire decentralized internet: cryptocurrencies, smart property, smart contracts, and decentralized autonomous organizations (DAOs) can all be created by simply writing a few lines of code.

The rise of governance by algorithm could force humans into making choices that are dictated by a network of faceless DAO’s attempting to optimize our existence. For example, if a DAO employer wanted to cut healthcare costs for an overweight employee, and the DAO paid the overweight employee’s salary in cryptocurrency, then the DAO may allow the employee to enroll in a program to set the employee’s smart wallet so he could not spend DAO issued cryptocurrency on junk food until his BMI was lower (or a more judgmental DAO could automatically enroll the employee).

Anyone who has seen the Terminator movies can envision how DAOs could create a society where basic human rights are trampled by algorithms.
For example, say a DAO owned by DAO shareholders operated a car dealership of autonomous self-driving cars, and a customer had insufficient funds, and the DAO was programmed to automatically lockout the customer at certain time if payment was not received, this could lead to horrible scenarios where a customer was in a sketchy area at midnight or a baby was locked inside the car on a hot day at noon. Then to top it all off, because of its decentralized nature a DAO, could not be held accountable via lawsuits or criminal charges for its actions.

FUTUROLGY?

We are still in the pioneer days of decentralized applications and we haven’t even imagined all the possibilities of smart contracts and decentralized applications, let alone decentralized organizations, but Ethereum finally launched its version just the other day.

Bitcoin to the moon?

Now that the speculative popping of Bitcoin prices has occurred (from $1200 to $400), are Bitcoin, Dogecoin and other similar crypto-currencies (bitcoins) the beginning of the internet or something destined to remain on the fringes of libertarian conspiracy theorists wearing tin-foil hats and posting cat memes on Reddit?  I don’t think there is much value in bitcoins as a means to hide the nature of transactions, as regular cash in a suitcase is better suited for such purposes (at least for now).  I also don’t think bitcoins will replace fiat currencies, meaning legal tender issued by a country’s central bank,  which is required to be accepted for the settlement of debts.  For example, you may be able to go to the moon with Dogecoin or sponsor a NASCAR, but the IRS will not accept Dogecoin to settle your tax bill.

The real value of bitcoins is to undercut the payments and cash management cartel of the SWIFT/CHIPS  cartel (Society for Worldwide Interbank Financial Telecommunication and Clearing House Interbank Payment System). On average banks and other money transmitters charge $40 for per international transfer.  Payments and Cash Management departments are one of the most profitable divisions of banking, as the sheer volume of money practically ensures profit, for example CHIPS handles 1.5 trillion dollars per day.

The  merchant fees charged by Mastercard, Visa, AMEX, etc are around 2 to 3 percent depending on size of the business.  To get an idea of how this amount adds up, WalMart is filing a lawsuit against Visa for 5.7 Billion dollars, based on approximately a 2% transaction fee for customers who use Visa at Walmart.

The size of the payments pie is enormous, and lots of venture capital will be drawn to this pot of gold.  However, for bitcoins to go from fringe to mainstream acceptance, the biggest nut to crack for bitcoin exchange operators to achieve a relatively frictionless anti-money laundering regulatory and the ability to seamlessly track capital gains and losses.  People, myself included, are lazy at their core, and do not want to track these hassles.

The IRS has issued notice guidance that bitcoins are considered property for tax purposes and not currencies, and that all users of bitcoins are responsible for to track their capital gains and losses whenever buying or selling bitcoins, similar to if you were trading in baseball cards or Beanie Babies, hence the need to track capital gains and losses.   However, when it comes to tracking down money laundering terrorists/slash drug dealers the U.S. Treasury Department Financial Crimes Enforcement Network (FinCEN) thankfully has advised that only “exchangers” and “administrators  and not “users” of bitcoin exchanges have a responsibility under the Bank Secrecy Act (BSA), Anti-Money Laundering (AML) and Know Your Customer Laws(KYC) to report suspicious transactions.

Where does that leave peer-to-peer bitcoin exchanges, similar to original Napster or current BitTorrent networks for the purposes of FinCEN enforcement?  Under FinCen’s guidelines, it is possible that anyone buying, selling, reselling bitcoins would be regulated as a Money Service Business on such an exchange.  How will regulators react with the development of technologies that enable users to scramble their payment information with another users?

With yesterday’s ruling by the Federal Election Commission and the combination of emerging technology, soon a user will able to send unlimited and anonymous payments to their favorite local politician.  On HBO’s “The Wire” Senator Clay Davis would’ve slept a lot easier if he didn’t have to worry about all of that cash is his trunk.