Blockchain Physical Assets
The blockchain originates out of the purely digital realm of Bitcoin. Thus blockchain networks themselves can only ever manage what is on the network. This is fine if the asset is simply a digital token, but going forwards we find ourselves increasingly wanting to use these networks to manage real-world assets, thus these value networks will have to interface with the real economy and this interface between the physical and information realms creates major issues. Economies are at the end of the day still very much physical systems of technology, land, natural resources, buildings etc. if we are serious about migrating our economic systems to the blockchain major consideration has to be given to that interface to ensure that the tokens are securely and accurately connected to their underlying physical assets. In a digital system like Bitcoin, there is always consistency. Transactions obey the rules of the software and there are no exceptions. In the real world, there are often exceptions. Cars are stolen, houses destroyed, videos turn out not to be properly licensed, commodities fail to be delivered – humans sometimes don’t obey the rules. Therefore the key challenge for any system that involves tokenizing real-world assets is to ensure that the digital token stays linked to the real-world asset.1
Very few people in the blockchain world have an appreciation for the complexities of the physical systems that run our economies and their regulation; such as containers passing through customs at a port. There is a huge gap between this very light dematerialized culture of the blockchain and the very heavy culture of traditional physical assets and the national legal structures that they are embedded within. Today this interface is secured by laws and ultimately the physical force of a government that backs those laws. If you have a legal document that says a piece of land is yours and someone comes and resides on it you can go to the government and they will physically remove that person from your property if need be. Imagine a token that represents a fractional interest in a set of gold bars in a vault. If a gold bar is taken from the vault, how will that be reflected in the digital token? Who will make sure that the token value stays linked to the gold bars that should be in the safe? Who will bear the risk and how? If the buyer of a token can’t be sure that the token is properly linked to the real-world asset, then the value of the token will fall or even become zero if no one has faith in the correspondence between the two.
At present blockchain systems are still dependent upon traditional legal frameworks for this linkage between the digital representation of an asset and the asset itself. Currently, arbitration is seen as one of the most effective ways of mapping between what is happening on the blockchain and what is happening with the physical asset and the legal systems it might be embedded within. Arbitration is a long since used method for creating legal agreements in international commerce where both parties agree to bind themselves into a legal contract of their making. An arbitration award is legally binding on both sides and enforceable in the court of choice. One way of linking legal systems to what is happening on a token network is through what is called a Ricardian Contract. A Ricardian contract places the essential elements of a legal agreement in a format that can be expressed and executed in software.2 The aim is to make the document both machine-readable and readable as an ordinary text document such that lawyers and consenting parties may read the essentials of the contract conveniently. From a legal perspective, the use of markup language embedded within a largely legal prose document leads to reduced transaction costs, faster dispute resolution, enhanced transparency and improved enforceability. From a computing perspective, the Ricardian contract is a software design pattern to digitize documents and have them executed within financial transactions, such as payments, without losing any of the richness of the contracting tradition. It is robust through use of identification by cryptographic hash function, transparent through use of readable text for legal prose and efficient through markup language to extract essential information.
Mattereum is one such project that tries to use Ricardian contracts to create an effective linkage between records on the blockchain and the established off-chain legally binding dispute resolution of arbitration thus giving what happens on the blockchain full legal weight under natural language contract.3 Mattereum is the first, what it calls “Internet of Agreements” infrastructure project for legally-enforceable smart contracts, enabling the sale and lease of physical property and other transfers of rights in assets. Mattereum is billed as a court that understands the nature of cryptocurrencies, making physical property and intellectual property transactable on a blockchain. In a case where you might buy a physical asset using a fraction of a Bitcoin and the seller does not follow through, it is difficult to explain this to a judge in a small claims court. This is where Mattereum comes in, enabling technically competent arbitrators to make rulings in these cases instead of a judge. As the founder of the project, Vinay Gupta describes it “Mattereum.com is my bid to get the necessary legal frameworks in place to make direct control of physical property using the blockchain recognized in 150+ countries. I want to break the door open to the material world so you can change the status of a smart contract, and have a real-world court recognize that legal ownership of a fiat asset has changed hands. Fiddly, but it’s necessary infrastructure for all of our next steps together.”
The alternative to depending upon traditional centralized legal institutions is depending on technology. Code may be the law on the blockchain but outside of those networks, Big Data and IoT will be law. Big Data is going to give us new insight into what happens when and where with high levels of statistical assurance, while at the same time IoT will put code into all of the technology around us that we are now so dependent upon and that is a new form of law enforcement. If you have the code that can stop a car or open a door lock then you control that system and can enforce whatever contract is on the blockchain. As an illustration, we might think about a blockchain IoT securitization of gold. We create an automated warehouse, people are allocated secure sealed lots within the warehouse. We deposit a stock of gold in one area and when someone purchases a block of gold the system automatically moves it to the owner’s container and the owners gold token account is calculated by summing up the gold in their container. This is a simplified representation of a blockchain cyber-physical system where blockchain records and tokens are linked directly to the underlying asset through automated technology. By an extension of this model whole buildings, cars and other assets could be directly connected to blockchain tokens thus bridging the gap between the virtual token and the physical asset.
1. YouTube. (2018). Sweetbridge SweetTalk #2: The Future of Contracts, Law & Commerce. [online] Available at: https://www.youtube.com/watch?v=cmWcWLKIHpY [Accessed 22 Mar. 2018].