The standardisation revolution
Standardisation of screw threads and the introduction of interchangeable parts in the late half of the 19th century were pivotal in driving the industrial revolution. They made mass manufacturing and componentisation possible, and were responsible for turning the tide of the American Civil War. In the coming years, standardisation of contracts will allow businesses to automate agreements cheaply and easily, and will drive a productivity revolution similar to that witnessed with the industrial one.
On April 21, 1864, a man by the name of William Sellars set the stage for standardisation of screw threads among engineers and machinists. He began with a speech given to industry professionals suggesting the need to agree on machining all screws with the same characteristics, and managed gradually to convince machinists across America to adopt a common standard.
At the time, American screws, nuts and bolts were custom-made, such that each one was potentially unique. This meant that there was no guarantee that screws, nuts and bolts made in different shops across the country would be the same and parts made in different shops could not be put together.
Similarly, the introduction of interchangeable parts had a significant impact. In the early part of the century, rifles were individually custom-made. This caused a problem during early warfare as each rifle was unique, and on the battlefield, if you had an issue with yours, it was largely irreparable.
This had begun to change by the time of the American Civil War, in that rifles became more standardised in their construction using standardised interchangeable parts — meaning it was possible to swap and replace parts of a rifle. This made it possible to not only mass-manufacture rifles, but also repair them on the battlefield.
Standardisation of seemingly simple things such as screw threads and interchangeable parts helped to drive the creation of the assembly line and mass production. This led to new efficiencies as components could be manufactured in distributed factories around a region and then assembled in a productive repeatable process.
Mass production added a tremendous value and impact on the manufacturing of components for everything from cars to washing machines. In doing so, it unlocked vast new productivity benefits and drove the creation of new jobs.
When it comes to global trade and productivity, standardisation is the big missing component. Contracts and agreements remain largely handcrafted and unique, which make them expensive to manage and difficult to scale. Although we have come a long way in terms of our legal capabilities, we simply haven’t reached a point where trade agreements are componentised and can be mass-produced cheaply. This is the big opportunity when it comes to digitisation and technologies such as blockchain, distributed ledgers and smart contracts. They have great potential to drive standardisation and unlock tremendous new opportunities for a new kind of mass production.
Smart contracts were first proposed in 1994 by an American computer scientist named Nick Szabo. They represent a set of promises, specified in digital form as well as the protocol for how these promises are performed.
They allow you to define the rules, conditions and penalties of an agreement in the same way a traditional contract does. The difference is that constructing contracts out of computer code adds significant new benefits and efficiencies. Smart contracts have significant potential for reducing transaction costs and providing opportunities for new kinds of businesses, social institutions, financial structures and agreements.
As Szabo wrote in his 1996 article Smart Contracts: Building Blocks for Digital markets, “whether enforced by a government, or otherwise, the contract is the basic building block of a free-market economy”. Contracts can be used in business relationships such as trade deals, personal relationships such as marriages, and social contracts between governments and their people. Contracts are a foundational element of our society.
Contracts are often very complex, representing centuries of cultural evolution that have established practices and common laws used to govern the agreements we enter with each other.
The cost associated with crafting contracts and navigating the legal structures built around them, particularly in our modern global world, are immense. The ability to digitise contracts offers the potential to unlock significant global productivity gains and opportunity.
Szabo outlines four basic objectives of designing contracts:
• Observability, the ability of parties to a contract to observe or prove their performance in adherence to it
• Verifiability, such that it can be determined if a contract has been performed or breached
• Privity, how the knowledge and control over the contents and performance of a contract should be distributed among parties
• Enforceability, the assurance that contracts are performed as intended
Smart contracts have the potential to greatly impact each of these four objectives. They can take accounting processes and automate them to the point where there are clearly observable insights into the performance of contracts.
Audit processes to detect violations of the contract can transition from being something that happens reactively to something that could theoretically happen in real time. There is the potential to provide greater protection and control over the information about a contract, its parties and its performance.
Finally, the improvements in observability, verifiability and privity lead to easier enforceability where enforcement can be automated or relegated to arbitration, with the arbitrator having access only to details necessary to determine a fair middle ground.
The key challenges facing the digitisation of contracts are that lawyers today are like 19th-century machinists who used to handcraft screws and components before the introduction of standardisation.
Business contracts are handcrafted where lawyers are like artists, crafting special provisions and tweaking language to provide an edge over counterparties in agreements.
The challenge is that handcrafted contracts don’t scale. Having lawyers handcraft legal contracts for nearly every deal adds a tremendous amount of cost and complexity to our society. The standardisation of legal agreements will be massively disruptive and unlock far more global capability and prosperity than the industrial revolution did.
In the same way that standardisation of simple elements such as screws and the introduction of interoperable parts paved the way for the industrial revolution, similar elements will pave the way for the smart-contract revolution. We are rapidly approaching the general realisation that we need mechanisms to standardise the core elements of many types of contracts to make them composable. Once we’ve achieved that, we will be able to scale them in a similar means to mass-manufacturing and drastically reduce the costs of interacting with one another.
• Denis Pitcher is a Bermudian tech entrepreneur with an interest in exploring the potential of blockchain and distributed ledger technologies for Bermuda. He is a fintech consultant to the Bermuda Government’s fintech Business Unit as well as a tech cofounder and chief architect of resQwest.com, a global tourism technology solutions provider. He can be reached at email@example.com