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The NFT Craze Raises a Big Question: What are Smart Contracts?

Tuesday, May 18th, 2021

Have you heard about “smart contracts”? Are they contracts like the kind you sign? What can you do with them right now? Will they replace lawyers?

They come up in discussion of the latest investment craze, NFT’s. Popular NFT’s include NBA Top Shot, digital art, and items that can be used in online games, like weapons.

NFT stands for “non-fungible token.” It’s a record stored on a blockchain of a unique asset. With an NFT, usually either there’s only one of something or a limited and numbered series of something. For example, with a digital art NFT, the artist might release a single copy for sale or a limited number of copies, each having a unique number.

Right now, smart contracts mainly are used to set a percentage of the resale price of the NFT that goes back to person who created it.

For example, in NFT art marketplaces such as OpenSea, an artist posting a piece of digital art for sale can set a rule as to what percentage of future resales flow back to the artist. Artists typically set that percentage at five or 10 percent. This is done by a special rule written into the NFT, which is recorded in and carried out by the blockchain. In this NFT world, all sales and purchases are in cryptocurrency.

This NFT example reveals that a “smart contract” is just a programmed rule carried out automatically by computers. Thus, a “smart contract” isn’t really a contract, although it might carry out a provision agreed to by contracting parties.

Instead, a smart contract is like an “if-then” statement in computer programming. You program the computer that if it observes a certain event occurs, then the computer does something specified in the program.

Once you view a smart contract as an if-then statement, you can see many limitations on what computers can do with them. Computers can’t detect many “if” events or carry out many “then” tasks.

First, consider the “if” part. There are some things a computer can’t know. Many possible “if” occurrences won’t happen on the blockchain, so information would be needed from the outside world.

In theory, a smart contract might be programmed to look on the Internet at a specific place for information to ascertain whether the “if” requirement has occurred.

For example, imagine a concert promoter taking out an insurance policy against it raining at the beginning of an outdoor concert, because that would depress ticket sales. In theory, a smart contract could be programmed to look at the website of the National Weather Service to see if it rained in a specific place at a specific time. Would that work? For insurance, it probably would matter whether it rained long and hard enough, and a computer might not be able to discern that.

In addition, a computer can’t judge whether certain types of “if” events occur. For example, sometimes, in a contract, a party is obliged to use “best efforts” to get something done. The party need not accomplish the goal but it has to try hard. A computer can’t judge whether that happened.

There also are certain types of “then” outcomes a computer can’t deliver. For example, if there is an online contract to sell a car, the computer can’t physically transport the car to the new owner.

Beyond if and then problems, a smart contract must comply with the law. The computer doesn’t know the law so it doesn’t know whether its process complies with the law. For example, consumer protection statutes frequently limit the amount of interest that can be charged on certain kinds of loans.

All of this means that, right now, “smart contract” is a sexy futuristic-sounding phrase but it has little beef.

It’s possible, as computing power increases, more things attach to the Internet, and artificial intelligence gets better, that smart contracts could do more things. But, even when that happens, lawyers won’t go away, but they will have to adapt. Lawyers will have to collaborate with computer programmers to write smart contracts that comply with the law and align with the human-language agreement intended by both parties.

In 1960, computer futurist J.C.R. Licklider published an article entitled “Man-Computer Symbiosis.” He described how humans closely collaborating with advancing computer technology can achieve big results. If smart contracting is to advance beyond the larval stage of paying royalties to original creators, we’ll need a lot of lawyer-computer symbiosis. Wouldn’t that be exciting?

Written on May 18, 2021
by John B. Farmer
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