With the dawn of corona virus, having parties meet to sign contracts poses potentially serious health risks and resultantly delays in the finalization of transactions. Although parties may elect to sign the documents electronically, the security and reliability of electronic signatures may lead to unnecessary and protracted disputes. A potential solution lies in the adoption of smart contracts. This blog post will detail exactly what smart contracts are as well as their key characteristics. The aim is to highlight the benefits of smart contracting for businesses in the modern era.
What is a smart contract?
The term smart contract was defined by Nick Szabo, as ‘a computerized transaction protocol that executes the terms of a contract’. Smart contracts are therefore self-executing transactions that contain the terms and conditions of the agreement between the parties and are written into a computer code and performed in an automated way. The code is designed to execute a transaction when set preconditions occur. The contract is only reactive and as smart as the self-executing code on which it is based as well as the factual accuracy of the data input therein. The computer code on which smart contracts are recorded contain the conditions of the contract and identifies the authorised parties/participants. Only the identified participants have access to the code and the terms therein. Any amendments to the terms of the contract may only be effected after approval of each party thereto. The computer code on which the smart contract is executed is called a blockchain platform.
What is blockchain?
Simply put blockchain is a shared, distributed ledger on which transactions are digitally recorded and linked together so that they provide the entire history on a single platform. Each transaction is encrypted to provide an extra layer of security. The ledger records all changes – which cannot be modified or deleted. Blockchain is said to be “immutable” because the records cannot be changed and is transparent because all participants to a transaction have access to the same information.
Uses of smart contracts
Smart contracts can be used in both simple and complex transactions to enable quicker performance and to help with cutting down on costs. Examples of instances where smart contracts may be used include contracts for mortgages or for trade finance. Regards mortgages the smart contract may be programmed to execute the contract in the following manner:
“IF/WHEN the X party transfers the property into my name in an electronic registry, THEN I’ll electronically pay the sum of money agreed upon. Or IF/WHEN I electronically pay the sum of money agreed upon, THEN the X party will transfer the property into my name.”
The code works on an ‘If/when-Then’ principle, which means that the contract is executed only when the agreed corresponding action is registered on the system in a manner similar to that expressed above. There is no limit to the conditions/terms you can include in a smart contract. These types of contracts can also be used in the insurance industry, real estate (as highlighted above), government transactions, supply chain etc. Essentially, they may be utilized in any transaction where the performance can be automated; it is only when the set conditions are successfully met, that the smart contracts would execute and validate the underlying transaction.
Characteristics of smart contracts
The intrinsic characteristics of smart contracts are numerous and unique in comparison to traditional contracts, firstly it eliminates the need for intermediaries – the contract executes itself, without the need for third parties. Moreover, since smart contracts are stored in blockchains they are automatically triggered in a decentralized way. Therefore, the administrative and related costs involved in entering into and enforcing smart contracts are lower than traditional contracts due to elimination of third parties like mediators and lawyers. Further, it is an automated process conducted through a code which eliminates manual process. It is also high speed, since the contract runs on programming code, therefore the speed of its execution is higher than the traditional contract. This improves efficacy of business processes and reduces turnaround time.However, this characteristic of smart contracts may cause problems, when there is a mistake in the language of the contract or in the coding of the contract, which would not be able to be corrected due to the immutability and self-performing nature of smart contracts.
Smart contracts are also immutable because they are stored on a blockchain, this means that once created they can never be changed again. This reduces risks since they cannot be arbitrarily altered once finalized. Moreover, all the transactions are stored and duplicated throughout the whole distributed blockchain system and therefore traceable and auditable. As a result, malicious behaviours like fraud can be mitigated. Smart contracts are therefore almost entirely fraud-proof since the records of the transactions are permanently kept on the blockchain.
Another unique feature of the smart contract is that it is distributed since it is stored on the blockchain; this means that the output of the contract is validated by everyone on the network and no outside party can manipulate the contract, for their own advantage or tamper with it. The smart contract is therefore secure because it is difficult to modify, in that once instructions are recorded, they can be executed, but cannot be interfered with.
An additional advantage of this type of contracting is that parties to the smart contract, by virtue of the contract being stored on the distributed system, can interact with each other in real time. This saves time and money for both parties who do not need to contract or communicate through intermediaries. The system also records all communications and therefore reduces the likelihood of disputes.
Many are concerned that smart contracts may render lawyers redundant and may result in difficulty regards resolution of disputes where judicial intervention is required, due to their complexly technical nature. This however is not entirely true, smart contracts are still contracts which require commercial lawyers to draft and review the legal terms of the underlying contract, which will be input on the blockchain. Widespread adoption of this method of contracting will lead to a merger between lawyers and coders who will need to work together for the smooth execution of smart contracts. Moreover, if disputes do arise, perhaps due to errors in the code or the code not performing in the manner intended by the parties, lawyers will need to be engaged to assist the parties in the resolution of the dispute. Should the matter end up in court, the highly technical nature of smart contracts may be simplified for the court through the calling as witnesses, of experienced experts in this field. Overall, the very nature of a smart contract is extremely beneficial to the parties thereto as well as lawyers since the entire history of the transaction is stored in a permanent system which cannot be tampered with.
Conclusion
Smart contracts have many technical peculiarities which result in numerous advantages for parties looking to contract online. They are significantly beneficial in commercial transactions because they eliminate the role of intermediaries since they are both self-executing and self-enforcing. In the current Covid-19 era they also provide a contactless but secure method of contracting since the entire transaction is dictated by computer code alone. By cutting out the “middleman,” transaction fees are also significantly reduced, while transaction speed is considerably increased. Where this method of contracting is adopted parties can enter into a wide variety of agreements without fear of default. The method to be adopted in contracting is a choice entirely up to the parties involved however with the numerous advantages presented by smart contracts it is a beneficial method worth considering. For more information on how to execute legally sound smart contracts, it is advisable to engage a lawyer with expertise in this area of law.
The information and opinions expressed above are for general information only. They are not intended to constitute legal or other professional advice. For clarification, questions or further discussion please contact the author Beatrice Moyo, on email at: beatricejoycemoyo@gmail.com
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