In this document we explore the concept of an Electronic Realtime Agreement (ERA) (aka smart contract) and its various uses within a legal context. The use of ERA rather than smart contract is primarily to neutralise the terminology being used and focus on the functions. First, we start with a simple outline of what is an ERA. Second, we look at different contexts where they are already used, such as the DRM or GURT. Third, we look at the purpose behind the ERA systems, namely breach prevention mechanisms and enforcement savings and an example of their usage within music distribution. Lastly, we look at how we can breathe life into digital assets through electronic original documents and financial instrument use-cases.
There are two main components of an ERA:
- A written contract
- Self-executing/ self-enforcing terms in code
Optional requirement: signed with electronic signatures forming an electronic original document.
Digital Rights Management (DRM) is an actual example of ERA in action. Under this scheme a software product is sold subject to licensing terms being that the software may only be installed a limited number of times. This is a written contractual term, however, at the same time, this particular term is self-executing. Previously, ‘rootkits’ (masked software to control machines) were used for example the Sony example in early 2000 of restricting the ability of a computer to copy a certain CD; this method has since been withdrawn. Internet-based or ‘always-on’ DRM seems to be a popular method today, examples include Steam gaming platform. Under this system, the user must, to access the content, remain connected to a particular server.
Another example of a ERA would be the Genetic use restriction technology (GURT). This product is not commercially available. The idea being that seeds are sold but that the second generation seed is sterile. This is, effectively, a smart contract. If you were to purchase a pack of seeds, the terms of the purchase would be not to re-use or cultivate any further seeds from the original seed (you would find this in the written contractual terms). However, the crucial commercial term, namely preventing the reproductive abilities of seeds, would be self-executing. Interestingly there are laws preventing the sale of GURT in India/Brazil.
Aim: Preventive Breach mechanisms
Regardless of the ethical considerations in above examples, these Electronic Realtime Agreements (ERAs) all aim to deploy preventive breach mechanisms.
This stems from, amongst other reasons, the imperative to avoid the cost of legal court based enforcement. Under normal circumstances an identified breach would result in a pre-action letter to assailant and court proceedings. With users based all over the world, enforcement now becomes a jurisdiction, battle of laws, and sovereignty issue. For instance, a copyright breach could be deemed a fair exemption in certain jurisdictions, such as the ability to lend materials to others and may, in fact, raise human rights based issues such as the example above of GURT. Therefore, the reason for self-execution is a massive cost savings on court proceedings with uncertain outcomes.
Example of ERA scaling electronic distribution
One of the interesting implications of a successful ERA (i.e. that the ERA code cannot be easily hacked or circumvented) is the ability to scale distribution of an electronic product/service with better profitability due self-enforcement of critical commercial terms and the by-product being savings on legal expenses to effect court-based enforcements. This is a potential holy grail of ERA. Imogen Heap distributes her music using Ethereum platform; the purchase, delivery and royalty split. This is a fantastic step forward in music distribution. The delivery of the music file (I presume) is linked to full settlement of the requisite amount of Ether which is the self-execution portion of the ERA. (It appears however that no DRM terms have been coded into the ERA system provided by Imogen).
Breathing life into digital assets
In law, physical documents are traditionally deemed originals. In certain jurisdictions a contract is only legally valid if it has been signed in the presence of a notary. That document then becomes the original and all others copies. For ERA to scale we have to ensure that the ERA is in itself the original. For that we have to thank Ian Griggs work on Ricardian Contracts and the ability to create an electronic original document with the use of, for instance, PGP signatures. (Of course, part of ensuring the enforceability of original electronic documents is the recognition by jurisdictions of electronic signatures; so there is still some work to be done on that side.). If we assume that we can create a legally valid electronic original document then we can progress the notion of an ERA in other ways; we can, in fact, start to breathe life into digital assets.
At the moment we have the Nasdaq LINQ project looking at the blockchain to manage company cap tables. We have the Docusign POC with VISA where the car identity and contractual changes are stored on the bitcoin blockchain. There are a number of ways that companies are exploring the use of ERAs. One particular area is the creation of digital financial instruments. Let’s explore that area in a little more detail.
Digital Bearer Assets
Bitcoin is a digital bearer asset. If you have it on your balance sheet (from an accountant’s perspective) it is deemed an asset and it functions as a ‘bearer’ asset with unrestricted legal transferability and a degree of anonymity on transfer.
However, it is difficult to legitimately and scalably digitise more advanced financial instruments without any identity attributes. This is not necessarily a technical barrier, but rather a legal/policy one. Bearer bonds/shares/ share warrants are no longer the prevalent format for financial instruments, in fact, in the UK (since May this year) there is a prohibition on their issuance.
Realistically, we have to look more broadly at this technology and see how to associate identity to the asset itself so that transfers can, in effect, be made between persons.
For instance, private blockchains aim to control access to the validation of the system (i.e. as Tim Swanson pointed out AML risks with anonymous miners) but also may be able to place more granular controls on how assets behave.
To have a digital asset, such as a share, move compliantly on a public blockchain, it will need to be an ERA. Thus, it will need to hardcode critical restraints on its transfer, such as the recipient of the share needing to be approved/identified by an intermediary and/or the issuer. Conventionally, a multi-signature control on the digital asset would place control over its transfer and this constraint may, in certain instances, be appropriate for private companies. However, a digital asset as an ERA should (of itself) be able to self-enforce terms without any intermediary intervention.
However, an area where further work is required is in the drafting of the written terms for ERAs. We can not seek to transfer digital assets seamlessly without some standardisation of written terms. This is what we have started to do with aperta.io. We prepared an open-source written contract for the trading of digital assets that can be referenced in any digital asset trade.
So in summary, an ERA has to have a self-executing/self-enforcing component. We need identity to be attributed to digital assets for the assets themselves to become more sophisticated and legal. We need the electronic document to be deemed the ‘original’ to breathe life into digital assets. We also need the ability for the digital asset to be an ERA and self-enforce certain contractual terms such as to whom the digital asset can be transferred. Lastly, we need to work on standardising the legal envelop of these contracts.