David Hoffman (YC 98), UPenn Legal Scholar of Smart Contracts and ICOs
David Hoffman is Professor of Law at the University of Pennsylvania, where his expertise in contracts, law and psychology, and empirical legal studies earned him Penn’s Award for Teaching Excellence in 2018. Mr. Hoffman is currently exploring the frontiers of contracting: how firms use form contracts as brands to better engage users with exchange platforms; the spatial distribution of unlawful terms residential leases; and the technical and legal issues generated by “smart contracts.”
He’s presented his “Coin-Operated Capitalism” paper at workshops and conferences hosted by a number of universities, including Columbia, NYU, UPenn, and USC, and has a forthcoming paper on “Smart Contracts.” Mr. Hoffman is Founding Blogger at Concurring Opinions, Founding Editor of JOTWELL Contracts Section, and Referee for the Journal of Empirical Legal Studies. He’s also a member of the American Law Institute, Philadelphia VIP’s LegalStat Taskforce data-sharing and analysis project, and Yale’s Cultural Cognition Project. He received his B.A. from Yale with a double major in Archaeology and History.
The Politic: Tell me about your background and how you got involved in blockchain!
David Hoffman: I am a law professor, and I have been writing about contract and corporate law issues for the last 15 years. Many of the issues involve how the law treats disclosure and how ordinary people understand disclosures that are either made in regular contracts or in financial products. A couple of years ago, a student of mine at the University of Pennsylvania wrote a “student note” (independent research done by a law student) about blockchain and smart contracting, which, at the time, I didn’t know anything about. This was around 2016, so it was pretty early on in the academic engagement of the technology. He wrote a really interesting paper about smart contracts and the costs of inflexibility. I think his paper remains one of the better pieces written about smart contracts.
After he was working through that note, I asked him what else I should be reading or learning about. Early 2017 was the beginning of the ICO bubble. He suggested that I would learn a lot about it by collecting examples or projects. I put together a research team to help me learn about the space, and from that learning and team emerged a paper which was trying to match project disclosures that were written in English, either in whitepapers, Twitter, Facebook, or Medium, with the actual code in the tokens or smart contracts that were being put out as their tokens or their medium of exchange. We found a lot of mismatches between those two forms of disclosure.
That’s amazing you were so involved with your student’s research. Is that level of commitment the norm, or were you just that sold on his idea?
I’ve co-authored with students in the past. This wasn’t the first time that a student project either inspired works of mine, or that I later co-authored with them. When I went to law school, I had a professor who would co-author with students if they took the initiative. I always thought that was a fair model of scholarship; I don’t think it’s entirely fair to use people’s research and just call them a “research assistant.” This particular student, Jeremy Sklaroff, is great. Over my career, I’ve had the luck of teaching students who were interested in taking the ball and running with it. Students can typically pay a little more attention to trends in technology, which I’m either unable to do or don’t have the ability to do.
Are you working on any other projects right now?
Yeah, I’m continuing to do research: I have an active research project about smart contracts, and I’m hosting a conference in the fall at Penn with engineers, lawyers, and others in the blockchain space to discuss DLT and smart contracts. I’m committed to keep doing work in the space.
Mind telling me a bit more about the paper you co-authored?
We took a look at the top 50 ICOs by revenue in 2017, and for every one of them, we coded the kind of things they promised investors on a variety of metrics. For example, did they promise to cap supply of the token? Did they promise the code would be immutable? Those promises could occur in a number of forms: the founder could have made these promises in the whitepaper, on Twitter, on a Medium post, on Reddit, or anywhere else. It doesn’t really matter where they made the promise.
For everyone one of the promises, we looked at the code issued by these ICOs. Around ninty percent of them had auditable code. The graduate student in Computer Science took a look at the code and noted whether it matched each promise. We found that the code did match the promise most of the time. In terms of supply restriction, the promises matched the actual code pretty well (31/41). In terms of vesting, the promises didn’t match the actual code well (8/37).
Most of the projects also failed to disclose that they had the right to modify the conditions of purchases on demand. This was news to the market. When we presented the paper and made it public, the findings were a bit of a shock to a lot of folks. The question was, “Why was it a shock?” These are pretty important economic attributes of the tokens being sold. From what we could tell, either through price data or through regular old discussion board chatter, the match between the tokens and the text was neither newsworthy nor what the market valued. We concluded that this phenomena stemmed from the market being in a bubble where prices were not rationally related to the underlying value of the assets. We predicted, and it turned out to be true, that there was going to be a correction in the market: the “Crypto Winter” (beginning on December 14, 2018).
Finally, we suggested what a better set of regulations surrounding these tokens and a better market would look like. We’ve had many conversations with government regulators in the years since. I think there’s some chance, to the extent that the ICO is a form that will continue, that the future version of the market will be better governed than the version we saw. And to clarify, ICOs are, of course, different from crypto in general. They’re also different from blockchain; ICOs are a use case of blockchain technology, but their success or failure does not mean the success or failure of blockchain.
Currently, there’s no real regulatory structure in place that would ensure better governance, and that’s bad news. The paper suggests that the ICO space is somewhere that regulators ought to be a lot more active, and where they ought to police fraud and make sure that actors don’t cheat people out of their money.
So if I lost money because a token developer decided to modify the terms of its service, for instance by changing the limit to its supply, I would have no recourse?
There’s no recourse in the blockchain [unless the code gives it]. Whether or not you can sue them in court would turn a lot on what jurisdiction you’re in, whether you can find the right people to sue, and then what legal theory you would have. The problem you would face is you’re engaging in buying a speculative good, and some courts might say that you should have checked the code yourself, that you were on notice, and that the court doesn’t protect you– regardless of what they say about restricting supply or vesting their assets. In other words, you ought to know that it’s not true, i.e., that it’s vaporware; it’s not fraud, because a reasonable people wouldn’t have relied on a promise contradicted the code.
The point of the article is to say that legal protections are limited with respect to what you can do in court. Many of the arguments for this market remaining unregulated were that the blockchain, or the code itself, would protect investors– and it doesn’t. So, you need to fall back on old-fashioned forms of relief, which are not super effective. Whether these discrepancies are nefarious is unclear. It could be that a lot of these people didn’t look very carefully at their code…
Are you working on any projects right now?
The project I’m working on now is getting a better sense of what smart contracts really are. There are a lot of discussions at a pretty high level of generality in the law, financial, and entrepreneurial literature, but I think people are actually talking about very different instruments when they talk about smart contracts.
I’m trying to write a paper with a graduate student in Computer Science where we explain the technology in a level of detail where you can understand what is and isn’t covered. We’re talking about what we think of as “contract stacks,” where you have semantic, old-fashioned contracts layered with DLT (distributed ledger technology) or algorithmic transaction scripts. We’re trying to understand the sorts of legal issues which will arise when things go bad with respect to those scripts, and what courts should be doing to set out rules that would govern those failed transactions– which, by the way, we’re going to see a bunch of in the next generation. The paper is an interdisciplinary project trying to understand where law meets code.
Mostly, I’m just trying to learn. I think this is an area where there’s a lot of ferment, a lot of change, a lot of different directions, and if you don’t try to go to conferences where you hear where people are going, you can miss developments.
Most of the projects we see aren’t going anywhere. But, that was also probably true of the 1998 internet bubble, where most of the things looked dumb, and where most people who heard a pitch on Amazon probably thought that was likely to fail, too. You can’t take the fact that most of the projects seem crazy and extrapolate that to believe that the technology, on a whole, is also crazy. That’s why I’ve been trying to talk to as many people as I can to learn about the relationship between the technology, its use cases, and the law.
It’s interesting that you’re a Professor of Law at the University of Pennsylvania, somewhere that people often refer to as a trailblazer in the space of cryptocurrency and blockchain. It’s also interesting, I should say, that the law school is often considered the pioneer of the space within Yale. What’s the scene look like over there? Is it also legal-centric?
Wharton is a real driver of entrepreneurial activity. There’s an alternative currency group at Wharton, there’s a lot of business students getting involved in ongoing projects, and there’s a ton of financial research being conducted. Kevin Werbach is pretty well-known in the space. They even cross-list courses between Wharton and the School of Engineering and Applied Science on blockchain. So, I would say to the extent that there’s valuable work being done at UPenn, Wharton and the engineers are leading the charge.
The law school has a Center for Technology, Innovation & Competition (CTIC) which some of my work has been sponsored by, and is a real leader in network design. Christopher Yoo, Director of the CITC, is one of the world experts on net neutrality and systems design.
I have nothing bad to say about Yale or Yale Law School; it’s an amazing institution, and there are lots of wonderful thinkers doing work on crypto who are more located in the college. Kate Klonick [a former graduate student, now at St. Johns], for instance, is terrific. Jack Balkin is an intellectual leader. The Yale ISP produces amazing scholarship and policy papers.
Many law professors aren’t really sure what this space will look like in five year’s time. It’s hard to know legal problems before they arise, and it’s hard to get your handle around a technology that’s changing so rapidly. So, maybe some people are a little averse to jumping into the pool, but at Wharton, they’re always looking for the next new thing.
Any final perspective for the readers?
Blockchain is a wildly interesting technology. I don’t think it solves as many problems as its adherents hope it does, yet I also don’t think it’s entirely about an alternative to money. So, there are really disruptive potential use cases for blockchain that don’t merely pertain to its relationship with the dollar. We’re not really sure which of the potential technological applications of blockchain are going to pan out and which ones are going to cost people money, time, and heartache, so I’d encourage students to keep an open mind and not fall in love with any particular idea. I hope they’ll think for themselves about how to best use their time, their resources, and their energy. And, I would probably encourage them not to invest in any ICO.