The future of Blockchain technology, applications and smart contracts
Written By: Stratton Report
August 25, 2017
Molly Suda is a partner at K&L Gates and is based in Washington D.C. Ms. Suda focuses her practice on regulatory compliance, enforcement, and transactional matters involving electric utilities, electric transmission owners, independent power producers, power marketers, and public utility holding companies that are active in the electricity, capacity, and ancillary services markets in the United States.
Stratton Report: Smart contracts are redefining the way transactions across all kinds of industries are being executed? What are some of the applications you see developing in the energy industry?
Molly Suda: I think some of the applications we see are developing around ways to reduce transaction costs and just automate transactions in a way that will allow for so called microtransactions. So if you take for example any energy trading markets, market precisions are really looking at smart contracts as a way to create self-executing smart derivatives which can really help reduce transaction costs. For these applications I think the energy industry can really pull from a lot of the work being done in the financial sector where they’re looking at ways to include smart contracts in derivative contracting. Then smart contracts are also being developed as a way to integrate distributed energy resources and electric vehicles in the grid and even potentially establishing peer-to-peer so called neighbor-to-neighbor energy markets. So take for example a peer-to-peer energy market running on a blockchain network that has a built in smart contract functionality. In the future, neighbors could set up smart contracts with a predefined trigger that would dictate when and how and on what price they would buy and sell power from one another. We’re also seeing Blockchain and Smart Contracts applications also developing to handle the billing and settlement of the electric vehicles where this sort of microtransactions can really achieve some reduced transaction costs from smart contracts.
SR: What are some of the other business impacts and opportunities you see coming out with the use of Smart Contract?
MS: The potential business impacts of these applications could be pretty significant. I think while the initial investment to transition to blockchain and smart contracts could be high like I said this reduced cost and these efficiencies might be more than sufficient to offset that investment. So in the energy trading example I gave, the automation offered by a smart derivatives could significantly reduce settlement time which could change how businesses think about credit risk and collateral management. Then in the second example about peer-to-peer energy market, Blockchain and Smart Contracts are really an enabling technology that would really have the potential to change the current business model in the US around how energy is bought and sold to end users and those new relationships and opportunities among end user customers and new businesses that really don’t exist in today’s power industry. So I think there’s a lot of opportunity there.
SR: Can you give us a simplified breakdown of how Smart Contracts work?
MS: Sure. So at a high level, a Smart Contract is really just computer code that programs into the Blockchain program and technology and then sits along other information stored in a shared ledger. And that code, it allows for the automatic execution of transactions that I mentioned based on predefined conditions. So for example, a predefined condition could be a particular price so that the Smart Contract is coded to take Y action if the price is X. There’s a pretty wide spectrum about how people think about smart contracts being developed and used. Some people think that they’ll still have the normal, natural language legal contracts have today but then some of those terms and provisions would be translated into code. So an example of that in the energy industry would be something like a power purchase agreement where one of the terms includes an option to buy power registered in a strike price. So you’d have a natural language legal contract for the power purchase agreement and that’s one term around an option. And that option term could be translated into code. So take for example coming that reads upon exercises the option by the option buyer, option seller will deliver a certain megawatt quantity and the option buyer will pay the strike price. All of those terms could be translated in code and executed through a smart contract and taking and improving a lot of the efficiencies and reducing transaction cost like I mentioned.
SR: What are some of the challenges that you’re encountering as Smart Contracts continue to develop?
MS: One challenge that’s just building off over the last time is translating natural language legal contracts into code and also standardizing contracts. Not all of terms in contracts want themselves to being encoded in a Smart contract. So take for example a choice of law precisions or terms that have some kind of subjective or qualitative element like obligations to act in good faith and make reasonable effort. The model for how these more subjective and qualitative terms will interact with terms that can be translated into a Smart Contract code is really part of an involving discussion around the development of Smart Contracts. And then standardizing contract terms is also a challenge if you have to write new code for each bespoke agreement. And if the Smart Contract code is not interoperable across different networks then you do lose that value of trends that reduce transaction costs and improve efficiencies. So we’re starting to see industry groups really sort of work through some of these standards for allowing interoperability.
SR: What about government regulation? What are the challenges there?
MS: The energy industry is a heavily regulated industry so addressing government regulation will be an essential point to the success of Blockchain and Smart Contract applications in the energy industry. So some of the first challenges, I think– would be helping regulators understand the technology and what it does and doesn’t do. Because of the potential for Blockchain and Smart Contracts to dramatically change business relationships like I mentioned, some of the next challenges will be addressing the rules and regulations that weren’t necessarily designed to accommodate this technology. So for example, to enable the type of kind of peer-to-peer networks I mentioned in the US, regulators and market participants will really have to figure out how to address that type of network and how those transactions can be fit within the traditional regulatory regime of retail and wholesale power cells and whether there’s any adjustments to those regulatory regimes that would be needed to accommodate these types of technology.
SR: What about cybersecurity? Can you talk a little bit about that?
MS: Cybersecurity is obviously a paramount concern in the energy industry. The energy industry is a constant target for cyberattacks and the centralized structure of the power industry that exists today has traditionally made it kind of more vulnerable to this fact. I think Blockchain technology and its distributed nature offers a lot of potential value when it comes to cybersecurity in a Blockchain network where data doesn’t exist in a single centralized location that makes it more difficult to manipulate data and tamper with the system needed to operate critical energy infrastructure. So if you have a malicious actor with a code injection or malware attack at sort of a specific point, this could be prevented or mitigated because unlike an attack on a central system or repository in a blockchain network that attack might only affect a single node and it would–in the blockchain technology in a distributed nature of it would prevent the attack from affecting the entire network.
SR: What do you perceive as the greatest obstacle for greater or wider adoption for blockchain and Smart contracts in the energy industry?
MS: I think the greatest obstacle is the coordination effort that’s going to be needed to ensure the kind of standardization and interoperability that I mentioned and making sure that these networks can accommodate new purchases to achieve the network affect attributed to blockchain. So we’re seeing a number of initiatives in the energy industry around blockchain and smart contracts which is great to see so many innovative ideas and platforms but to obtain these values that I’ve identified, market participants will really need to collaborate and coordinate their effort. And this will really be especially important I think in the context of advising regulators on how regulations might need to change.
SR: What do you think is going to be the major role of legal firms such as K&L Gates as smart contracts become more mainstream?
MS: So I think that some might say that smart contracts would spell doom for lawyers and I think I would disagree with that. I think there will certainly be a role for lawyers in helping clients evaluate how smart contract could interact with natural language legal contracts like I mentioned above and there’s also a role for lawyers in advising clients on the regulatory regimes and rules that could affect or interfere with the development of smart contract application and just also advocating through those role changes. In that context, I think lawyers will really take key role and hoping to build consensus and coordinate the efforts needed to achieve the wide scale of option.
SR: Considering there are hundreds of both blockchain and artificial Intelligence startups and sizable venture capital investments growing rapidly and exponentially, how likely is the possibility for boom invest period such as we had in the dotcom era and what can the industry do to circumvent the impacts that might happen?
MS: I think you often hear people talk about the parallels of the internet in the 90s and in 2000s to blockchain today and I certainly think that there’s a view out there that we’re starting to see a similar kind of blockchain boom that happened with the internet and particularly around a number of initial coin offerings or ITOs have grown. And I think until somewhat recently ITOs have been used with relatively little guidance from regulators and I think as you see more guidance from regulators and more activity around a regulation of the objective offerings and blockchain technology in general that might mitigate the risk of the similar boom and bust cycle and then also just with more guidance from regulators and advice from legal counsel, I think investors and market participant just made better informed decisions about what blockchain or smart contract technology to invest in.