Can smart contracts uncover the secrets of your business?
Smart contracts have the potential to deliver live, real-time business intelligence to companies and whole economies, helping transform legal functions into engines of strategic thought. But will it happen any time soon, or will adoption be slower than anticipated, like other elements of legal AI?
We talk to WorldCC's Sally Guyer, Trakti's Luigi Telesca and David Halliwell of Pinsent Masons about the business intelligence byproducts of smart contracts.
Hello and welcome to Brain Food for General Counsel, where we look at the biggest issues facing your organisation, and how the legal function can help. My name's Matthew Magee, and I'm a journalist here at Pinsent Masons.
Imagine if you could present to your board a perfect, real-time picture of the economic activity of your organisation: every deal, transaction, payment and purchase. You would look good, sure, but more importantly the behaviour of your organisation would be transformed.
A surprising amount of business decision making is done with imperfect information about what is actually happening out there in the company. And what information there is often only exists because of a massive expenditure of resources.
The organisation that has accurate, real time data is instantly at a competitive advantage. They can analyse spending and resource allocation more efficiently, but they can also create a strategy for the future based on the real world, not the sometimes-optimistic picture painted in boardrooms.
Providing this is one of the promises, and almost one of the accidental by-products, of smart contracts. But is the promise real? And can it be delivered at scale any time soon? We'll try to
find out from contracts advocate Sally Guyer of WorldCC and Luigi Tesca, who runs a smart contract platform provider. And we'll get a view of the situation on the ground from David Halliwell, who's in charge of client solutions for Pinsent Masons.
Smart contracts are digital versions of agreements with processes contained within them to verify that certain events have happened and execute an action based on it. So if I'm a car-maker and 2,000 exhaust pipes arrive at my factory from a supplier on time then the payment to that supplier is automatically made, perhaps with an agreed bonus if they arrived early.
They are part of the much-touted emergence of artificial intelligence in commercial law, an area that for many organisations appears not to have lived up to the promise of the mid 2010s. But smart contracts are at the concrete end of what was promised and do actually exist out there in the real world.
Providing business intelligence – data about what's actually happening right now in your company – was never their primary function, but it could be one of their most powerful attributes, uncovering the secrets of your organisation almost as a by-product of executing agreements.
Because a contract is a record of economic activity. And economic activity is what makes a company a company. A digital contract is more than a record, though: it actually undertakes this activity, and creates a trace of every transaction. This can be broken down and analysed in any way the organisation wants: who is doing deals? Who are our customers? How many miles of piping were bought yesterday? How much inventory is in our Delhi depot? What is our exposure to a depreciating dollar?
It's a big promise and we'll assess later how realistic it is, but first Luigi Telesca, co-founder of Trakti, outlines what gold lies in those smart contracts.
They can get a lot of data, because first of all they would not see anymore a contract as a static document like an attachment to their daily routine, they will see the contract as a binder of information that is not only information about the deal that they have signed, but also how actually the deal is processing over time so that they can understand for example if the connection with their counterparty is stable, is it improving over time? So it becomes a dynamic object. What they can get is information about intangible assets, they can get information about trust, they can get information about quality, they can get information about repository of the relation. Things that today first of all are not there because they are scattered between different systems, secondly they are not providing data real time, but the data is inputted manually by people that are really interpreting the value maybe even with some mistakes into it while the system can get it automatically.
And what is possible on a company scale is possible on an economy-wide scale. Sally Guyer runs World Commerce and Contracting, which promotes standards in contracting. She and Luigi are working with the European Commission to see what this kind of data could do for whole economies.
Existing measurement systems like gross domestic product, well they struggle to account for those intangible structures and assets of today's economy. Approaching measuring economies as an ecosystems of contracts actually allows you to start measuring those intangibles that we have not really been able to. It is a shift, but it is a really important shift as well, all of the data that is produced by networks, by market structures. One of the case studies that we are using is Airbnb, with all of the transactions that happen across that platform, we can start to measure those in a way that GDP was never structured to do it.
There are concrete benefits here for legal teams - if a series of systems now takes care of routine actions associated with long-ago negotiated contracts, what impact does that have on legal teams? Luigi, then Sally, then David Halliwell ponder whether this releases teams for more strategic work?
The word you said – releasing - is amazing. It is exactly the one we need to use. I think there is time wasted in administrative activities that is not paying out. By creating automation that can actually focus on what matters to the business and also try to avoid costly litigation that actually could raise after, because they would be able to plan a common level playfield to work better with the counterparts. Also to review the risk because the contract would be able to mitigate risk by getting real time data, it would give immediate indicators to general counsel on which contract deserves attention or not. Before, the risk or the problem is created.
Everything is automatic, so we do not have to go through a process of manually assessing whether a delivery was late or on time. What does that mean? I need to go to finance, I need to draw up some paperwork, I need to ask my finance department to make the payment or to issue a penalty notice because its late, so there is all of that back and forth and various different departments being involved in a process that the smart contract approach just eliminates. I think it will change the legal function and I think very much for the better. I mean many of the organisations and legal functions that we work with at WorldCC are desperately trying to eliminate a lot of that bureaucracy and admin frankly. I think there is a huge amount of opportunity for legal teams within a business to become far more integrated with the business and far more strategic on that basis as well.
There is a whole wide range of things that legal teams can do to get the right work on their desk and to get the wrong work being dealt with elsewhere, so quite often that can be fairly basic things like creating standard checklists for commercial people in order to be able to negotiate contracts themselves. Where clients have done something quite basic like that the legal team is able to take a more strategic view of the things they are doing because their resources can be spent, their time can be spent looking at the bigger issues rather than the day to day legal queries.
Smart contracts have got the potential to turbo-charge that as well. So not only will a lot of the processes around contracting be automated but they will provide the legal team with volumes of data about the risk position of the organisation which will enable the legal team to really become more strategic. They will be able to analyse where contract risk sits. They will be able to look at ways in which contracts are being managed and they will be able to organise the whole of the businesses approach to contracting in a way that delivers full value at those contracts.
There is a whole wide range of surveys run by organisations which identify the existing value which is hidden within contracts, obligations which people do not know about, rights which they have to enforce contracts: it could be price increases it could be reviews of the terms of the contract, it could be a whole range of things to their benefit which they are simply not able to do because they have forgotten that they are in a contract. If these rights and responsibilities and obligations get incorporated in their technology systems then it means that they are being identified, enforced and implemented automatically and that will enable the legal function to really demonstrate the value it can bring through better contracting.
This is where, though, we get a little into chickens and eggs. Using this technology will not magically re-engineer your approach: you need to do that to use the systems. So a lot of hard work still needs to be done to get the benefits. David Halliwell has been talking to companies about how they structure contracting and has found that this all might be a bigger challenge, and a lower priority, than advocates of it might like.
I think a lot of people love the idea of smart contracts and in the same way that there is a lot of excitement about blockchain and its opportunity to improve contracting and business transactions generally there is relatively limited detail, understanding and uptake about how these technologies can actually be used.
So, we have been talking to a whole wide range of clients within the financial services sector and some of the biggest household names you can imagine, and this is really nowhere near their agenda at the moment. You would think that banks, for example, who have customer facing contracts, supply contracts, fully integrated into the whole of the operating model would be really approaching smart contracts with which is something going to add significant value to what they are doing. But, from the conversations we have been having they are still dealing with some fairly rudimentary contracting issues which they need to get right before they can think about anything fancy like a smart contract.
We quite often work on large document review projects at times and the key thing that we need to do there is to get hold of all the contracts. It could be because they are about to do a piece of M&A and they need to know what their contractual state is, when they are either buying another party or selling to another party, but the vast majority of clients do not know where their contracts are and they could be on local c: drive, they could be with people who have left and do not know where. Simply finding where all your contracts are is one of the biggest challenges for clients at the moment. So, yes you are absolutely right, get them all into one place would be a massive advantage and in a sense a starting place for something like smart contracts, but a lot of the clients and corporates that we talk to are a long way from being anywhere near that.
We have been talking to a range of financial services organisations about their approach to technology, comparing where they were in 2018 with where they were in the second half of 2020. One of the questions we asked them was what was their approach to data? Has it got better over the last couple of years or has it got worse? A third said actually yes that their impression in relation to data is better, they have got better data structures in place and they are better organised. On the other hand, 20% of them said that their profession has actually got worse over the last couple of years and the remainder says it has not changed at all. So, there is a clear understating that getting your data right and getting your data structures right will enable all sorts of good things, but in big organisations that is the very significant effort they need to go to get to the sort of improvement they need to be able to make.
Luigi and Sally say that though adoption is in early stages, it is being used out there in the real world: by financial services and fintech companies; in insurance and healthcare; by the Swedish Land Registry and the US's General Services Administration.
What nobody really doubts is that smart contract use will grow and they will become a widespread part of doing legal business in time.
Sally says that this will help organisations get back to a sense almost of contractual purity – away from thousands of pages of doom-mongering, and towards what contracts started out as: enabling agreements as a foundation for doing business.
What should have been ostensibly simple tools to guide cooperative activity have been completely corrupted over the years. Layers upon layers have been added to contracts by this sort of predatorial or defensive intent. Contracts have had such a bad rap, but they are the lifeblood of organisations. They are data-rich and actually being able to capture transactions, creating that level of transparency and visibility and all of these different transactions. They have a huge impact on economics, on society as well. Shifting to a mindset that recognises the fundamental importance of contracts, the data that they hold and using contracting as a data source for an organisation, I think it is incredibly logical for us to be shifting in that direction.
Agreements have become so convoluted that most normal human beings do not understand them. There is a reason the contracts that are put in a drawer and not looked at unless something goes horribly wrong. They used to be much simpler. There was one fascinating example in the oil and gas industry where contracts today are 1,000 pages and back in the '60s, '70s that same agreement was written on a single page.
We are moving away from the artisanal approach to contracting to a much more scientific approach and breaking contracts down into their component parts, standards are going to be an essential part of the path forward as we increasingly digitise. The ability of smart contracts to eliminate the artisanal approach, the opinion based approach to contracting and the 'my word is better than your word' approach, that has got to be applauded.
The promise is substantial, but there are some unusual challenges, and one of them is the climate. Smart contracts as currently envisaged are based on block chain, a collection of code, algorithms and public records that can verify identities and authenticate transactions. It is the same technology used to underpin digital currencies like bitcoin. But when used in currencies the amount of energy needed to do the processing necessary to authenticate and verify is staggering – a Cambridge University study recently claimed that bitcoin uses as much energy as Argentina.
So is it really sustainable to propose that all large businesses underpin every contract with this technology?
Luigi explains that the energy used is inversely proportionate to the amount of trust in the system – the less trust there is, such as in a currency where people don't know each other, the more power is needed in the system. Large businesses contracting with each other should not need to consume so much energy, he said.
Bitcoin is a specific blockchain implantation that because it is trustless is requiring a lot of energy because in order to solve the problem of trust they need a very complex cryptographic engine that requires a lot of energy. There are different implementations of block chain that are very fast, they can streamline processes, they are energy efficient like the cloud. The more trust between parties, the less energy is needed because the block chain was born in order to solve the problem of trust. And how to solve the problem of trust if you do not trust the counterpart is to basically create and put mathematics on top of it and to use mathematics as a proof of trust. In that way we do not have to know each other, but I can send you a bitcoin and you know you will receive a bitcoin and I will not have bitcoin in my wallet.
If instead we know each other, we already trust ourselves but we want to have a tool that is functional, is keeping records up to date automatically and sharing information, maybe we do not need that complex block of certification of transaction. We can just share the information in an immutable system and that is more than enough. In that case we use a different concept of trust that these variations are to the ones we use in banking system. It is the one between banking clearance processes, but in a more disfigured fashion.
The potential business intelligence benefits of smart contracts is mind-boggling: a real time ledger of economic activity by company and across the economy. Strategies would be rooted in real activity; economic planning and policy would be based on sound data, and intangible elements of the economy would for once be fully considered.
But as with all things related to artificial intelligence and technology in law and business, some pragmatism and realism is needed, as David explains.
Ihave compared the situation to where people were a couple of years ago and talking about artificial intelligence. We spoke to financial service organisations two years ago and asked them if they had to look forward to the heady heights of 2020, what would they anticipate as being their most used technologies at that point? And the sort of things which are required in order to implement smart contracts were all there on their wish lists. They thought they would be using technology to automatically tag contracts to create management information; they thought they had better technologies in there to predict contract risk using artificial intelligence; they thought they would have technologies in there to help them with decision making.
Scroll forward to 2020 when we revisited this with them again, those technologies were nowhere near either what they had already implemented, or they were thinking about for their two year horizon looking forward again. They had gone back to some fairly standard day to day technologies, some basic contract drafting tools which might involve some contract automation, potentially thinking about our contract management day to day, but the idea that artificial intelligence was going to solve all of these challenges for them was a pipedream.
People thought you would be able to implement this technology fairly rapidly and it would make significant changes to your ability to manage contract risk, but not only has that not happened yet, people have now taken that off their agenda the things that they want in the future. They are now focusing on much more day to day pragmatic tools: how can they improve their contract drafting, how can they improve contract management. If you are a legal team what is your relation with the business like in terms of a portal for instructions or Q&A tools to enable the business to be self service.
People are now in a much more rudimentary place in terms of understanding what technology can do. Yes, there is a long-term aspiration to be able to use artificial intelligence and some of the blockchain and smart contracts technologies, but for the vast majorities of the businesses that we talk to, it is not on the horizon for the next two to five years.
Then again, David reminded me, e-signatures have been the next big thing for nearly ten years with only piecemeal real-world adoption. Then Coronavirus and lockdown happened, and they were everywhere, their time had come. He recognises that events could quickly make these contracts, and the business intelligence they produce, as ubiquitous as e-signatures have become in the past year.
Thanks for joining us for the latest Brain Food for General Counsel podcast. Remember you can keep up to date with hour by hour coverage of business law news by the Outlaw reporting team at Pinsentmasons.com. Do not forget to subscribe to us wherever you get your podcast, and if you have enjoyed this or past programmes please do rate and review them, it helps us to reach other people who might be interested. Until next time, goodbye.
Brain Food for General Counsel was produced and presented by Matthew Magee for Pinsent Masons, the purpose-led international profession services firm with law at its core.
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