The Minimum Hybrid Contract (MHC): tying legal effect to blockchain immutability

Updated: Apr 8, 2020

Jørgen Svennevik Notland - School of Entrepreneurship, Norwegian University of Science and Technology (NTNU);

Jakob Svennevik Notland - Department of Computer Science, Norwegian University of Science and Technology (NTNU);

Donn Morrison - Department of Computer Science, Norwegian University of Science and Technology (NTNU).

-- The type of financial institutions a country ought to implement has, for the last three decades, mostly revolved around discovering and implementing the ideal mechanisms for achieving a free-market economy. At the heart of these debates has been the question of how a free market economy can be secure, accountable, transparent, and inclusive to the actors involved, with some of the key solutions to these issues being particular financial regulations and legal contracts. Moreover, while it is the corruption occurring in developing and emerging economies outside the West which gains most of the media attention, it is essential to note that the issue of corruption is also a significant challenge for developed countries.

To overcome the challenges of corruption and reliance on a trusted centralized third party, we propose supplementing the existing legal regime with smart contracts where a smart contract supplements the legal contract. Our approach, called the Minimum Hybrid Contract (MHC), and outlined in our recent paper, "The Minimum Hybrid Contract (MHC): Combining legal and blockchain smart contracts," seeks to incorporate the accountability and transparency of smart contracts into the realm of human judgment and discretion.

The argument advanced in our paper is that, in addition to using a court for legal disputes in contractual relationships, supplementing the legal contract with blockchain as a tool for setting the rules for financial transactions provides transparency and immutable transactions while also lowering the cost of conducting due diligence and suitability assessments by lowering the cost of information sharing.

The MHC consists of a legal contract that is supplemented by a smart contract. The smart contract facilitates transparent and secure transactions with immutable records. Given that a civil court handles disputes at the mercy of a legal contract between two parties, the MHC can be a tool for solving issues of low trust in contractual relationships.

Because smart-contracts are borderless and jurisdiction-agnostic, several jurisdictions including domestic and local jurisdictions can collaborate on cross-jurisdiction MHCs. This empowers the MHC to facilitate transparent transactions across borders and interconnect jurisdictions.

The MHC offers transparency and immutability for financial transactions, and the receipt for a transaction is indistinguishable from the transaction itself. There is zero opportunity to fake receipts, and thus receipt fraud is theoretically impossible. Using MHC's immutable and transparent transactions for cost-accounting can reduce the risk of illicit activity because of superior reliability and cost-accounting.

Financial information is usually costly to obtain and flawed. The price of information decreases when using MHCs, as there is no longer a need to employ an auditing firm to review financial records, and there is no need to trust the auditor and the issuer and safe keeper of the receipt. One party in a contractual relationship can audit the records in the MHC smart contract to prove which past transactions were signed using the corresponding party’s public key-pair.

Blockchain regulation strategies are needed to set forth a pathway for adopting the MHC. If blockchain is made illegal, the MHC cannot use a smart contract as a supplement to a legal contract. The recommended strategy for pioneering regulators is to implement safe harbors and regulatory sandboxes where specific blockchain-related activities are excluded from legal obligations.

The MHC also is more trustworthy and makes auditing more cost-effective. Ultimately it succeeds in mitigating moral hazard, information asymmetries, and monitoring costs emphasized by agency theory. To utilize it for societal well-being, it is essential to find a golden middle way between private and transparent transactions, striking a balance between transparency and the basic human need for privacy and keeping secrets is a must.

The implementation of the MHC smart contract now runs openly on the Ethereum blockchain on this Ethereum address 0xC0e817d3e3D79085175BCD83BD899A3d06BC1C8A. Anyone can use the smart contract in that address to immutably link a legal and smart contract. See the documentation in the MHC Git repository for more details.

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