It should not come as a surprise to learn that Web 3.0 and the Metaverse are set to shake up the legal and regulatory landscapes over the coming years. These new technologies are transitioning from the fringe to the centre of legal practice and lawyers must stay ahead of the curve to remain competitive. Digital literacy, namely having an understanding of how they work and what their implications are for legal practice, is key. Metaverse 101 is a miniseries of blog posts aimed at breaking down Web 3.0 and the Metaverse and giving you the basics of what you need to know. First up: blockchain, distributed ledgers and smart contracts.
What are ledgers?
Ledgers are simply books of debit and credit transactions. There are both single ledgers (e.g. for an individual’s dealings with you) and multi-person ledgers (e.g. for tracking transactions within a marketplace). In the context of blockchain, ledgers fall broadly into three categories: financial ownership (e.g. bank accounts), property ownership (e.g. asset registries), and ledgers for recording the use of a particular system (e.g. any credit-for-use system).
Gone are the Dickensian days of accountants recording transactions in leather-bound books. Old-fashioned, non-distributed (single) ledgers face a plethora of issues including:
- Single point of failure: stored on single computer systems and may be interrupted or lost if the host system goes down or ceases to operate.
- Individual data entry: data uploaded to the information set is only as good as the single system that uploads it.
- Bad actors: stored on single computer systems and therefore easy to target and corrupt.
- Erasure or overwriting: may be erased or overwritten if someone has the means to access the information set.
- Trust and reputation: there must be a relationship of trust between the participators and the ledger-keeper.
- Interoperability: not automatically interoperable with all other external organisations.
The usual way to solve these issues is to throw money at them: backups and failovers help mitigate the risk of the single points of failure, internal processes may alleviate the risk of individual data entry and prevent accidental erasure and overwriting, data protection systems may safeguard against bad actors, regulation enhances trust and reputation, and industry bodies may promote the interoperability of ledgers. Not only are these solutions expensive, they are also inefficient.
Distributed Ledger Technology (“DLT”), such as the blockchain, provides another way to solve these problems:
- Single point of failure: having multiple versions of the ledger ensures that it is always available and its reconstruction is always possible.
- Individual data entry: changes to the ledger are made by consensus meaning that no single upload’s error should make it through.
- Bad actors: the blockchain’s Proof of Work protocol enhances the security of the ledger.
- Erasure or overwriting: the blockchain cannot be erased or overwritten, it can only ever be added to.
- Trust and reputation: participants place their trust in the system and not each other.
- Interoperability: the blockchain is an open network meaning that anyone can view and build onto the transactions that occur.
What are smart contracts?
Smart contracts are essentially computer programmes which run in whole or in part without the need for human intervention, and are deployed in a variety of ways, such as for performing transactions on decentralised cryptocurrency exchanges, facilitating games and the exchange of assets between participants on a distributed ledger, and running online gambling programs.
Importantly, a smart contract is not by definition a smart legal contract (“SLC”). Legally binding and enforceable, a SLC is a contract in which some or all of the contractual obligations are defined and/or automatically performed by a computer upon execution. There are three types of SLC:
- Natural language contracts with automatic performance by code: the code itself does not define any contractual obligations (and so novel legal issues in contract formation and interpretation are rare). This type of SLC is the most commonly used.
- Hybrid contracts: some contractual obligations are defined in natural language and others in code. Some or all of these obligations are performed automatically by the code.
- Contracts recorded solely in code: all contractual obligations are defined in, and performed automatically by, the code. Given that no natural language version of the contract exists, this type of SLC presents the most legal challenges.
Like most emerging technologies, SLCs are facing many hurdles that must be overcome before their mainstream adoption. Issues surrounding formation, interpretation, remedies, consumer protection and jurisdiction are common. In regard to the latter, when disputes arise in relation to a SLC, it can often be difficult to identify the location of the defendant, the location of any digital assets, the applicable law, and the SLC’s place of formation.