Bitcoin has been making a lot of headlines recently since its value has increased roughly three hundred percent over the last two months. As Bitcoin has garnered attention, many experts have thrown around the term “smart contract” in reference to the software that supports Bitcoin. Understanding smart contracts is not easy, but it is becoming clear that smart contracts have features that make legal contracts more efficient and will likely be an integral part of contract law in the future.
The term smart contract is used to describe code embedded within a blockchain that states and verifies the performance of terms for a given transaction. A blockchain is a digital ledger that records all of the transactions chronologically and publicly within a distributed network. The record of a given transaction is assembled into a data block and added in a long strand of recorded transactions. In other words, the blockchain is the long recorded chain of transactions. A smart contract is the code that sets out terms and ensures performance of an agreement or transaction.
The term, smart contract, was originally proffered by the computer scientist and cryptographer, Nick Szabo. Szabo authored the paper, “The Idea of Smart Contracts” where he suggested that computer code could supplant written terms of a contract. The paper analogized a smart contract to a vending machine. In Szabo’s example, the transaction takes place within the vending machine. The buyer performs one term of the agreement by putting money into the machine and the vendor has programmed the machine to dispense a product thereby fulfilling the performance. Szabo extrapolated on that idea and explained that complex transactions could occur using the same methodology using code. For example, a smart contract is the code that describes, “if money is given, then Bitcoin is dispensed.” However, the typical value-for-property exchange (i.e. Bitcoin) is just the tip of the iceberg. As smart contracts perform more complex functions and implement more complex conditions, they can reduce transaction costs, promote predictability, and permit transactions to be conducted faster.
Smart contracts have garnered significant appeal due to their ability to increase the efficiency of some transactions. The software makes transactions more efficient by cutting out the need for various intermediaries that are necessary to a successful transaction. Escrow agents, bank accounts, postage, and other entities are no longer required to complete an agreement. The blockchain is the gatekeeper that can hold property or dispense property once the terms of an agreement are met. This function is unique because it does not require human oversight but is instead conducted by an intertwined network of computers that possess the blockchain software. Without human oversight and by computer power distributed between all computers connected to the blockchain network, companies only need to spend money on coding and they can eliminate the cost on intermediaries and even legal services used to construct contracts.
Despite being overshadowed by the finished products; smart contracts could revolutionize contracts in various commercial settings.
One of the signature benefits of smart contracts is the multiple-verification platform that allows multiple parties to engage in a contract. For example, consider a contract where buyer requests a shipment from three different sellers. The smart contract dictates that buyer does not pay any of the sellers until all shipments are received. The buyer places his purchase money into a blockchain where the terms of the agreement have been reduced to a smart contract. The blockchain acts as an escrow agent awaiting performance by the other parties. As each party performs, the smart contract verifies the performance and then dispenses the purchase money when the obligations are fulfilled.
Another feature of smart contracts includes the software’s ability to increase the predictability of contracts. The terms for any given smart contract cannot be altered during a transaction and each party, theoretically, should have equal bargaining power. Smart Contracts are basically boilerplate terms on a given blockchain. With uniform boiler plate terms (code) and software that verifies each parties performance, the possibility of a breach or a misunderstanding about the deal is unlikely. These features creates contracts with predictable results that do not lead to litigation.
The brilliance of the software has been overshadowed with the mysticism behind cryptocurrencies like Bitcoin. However, despite being overshadowed by the finished products, smart contracts could revolutionize contracts in various commercial settings. Financial institutions are starting to realize that smart contracts could cut costs of transactions and make more efficient consumer contracts. Santander Bank conducted a study showing that their bank could save twenty-two billion dollars by 2022 by the utilization of blockchain technology run on smart contracts. The study was based on their innovation fund called Santander Innoventures. The study found that smart contracts could reduce cost and improve the accuracy in accounting. In addition, smart contracts reduced the cost and increased the speed of financial transactions. Smart contracts could improve the supply chain businesses as well. A shipping company may have a contract that says if cash is received on the blockchain, then goods will be shipped to the buyer. This fund is part of the bank’s agenda to explore new technologies in the financial world. The results suggest that smart contracts are likely to become an integral part of conducting financial transactions due to the software’s ability to reduce cost and improve the speed of a transaction.
In real estate transactions, a blockchain that is supported by smart contracts could substitute an escrow account. The buyer could put money in a secure blockchain. When the seller has performed a function, the performance will trigger a mechanism within the blockchain that dispenses the funds to the seller. Georgia, Ghana, and Honduras have implemented blockchain technologies in order to help facilitate real estate transactions. The efficiency, transparency, and integrity of the real estate transaction can be promoted through smart contracts.
Mishaps in coding could lead to financial loss and negatively impact businesses.
The benefits of smart contracts are numerous, however, significant strides in smart contract software development are required before these applications are implemented into the industry. Smart contracts are limited in their capabilities due to the difficulty to reduce complex terminology and terms into code. Current smart contracts are simple in that they are programmed to deal with performance in payment and transfer of a “thing” such as a good or something of value. When other more complex terms with multiple contingencies are required, the necessary code is considerably more complex and difficult to frame into code. In addition, the code needs to be accurate in order to ensure that the blockchain does not perform incorrectly. Mishaps in coding could lead to financial loss and negatively impact businesses.
Litigation regarding contractual disputes could be ineffective since the attorneys and judge would have to have some knowledge regarding code and how to interpret that code. The alternative is to rely on expert witnesses to infer the meaning of contractual terms from smart contracts.
Another detriment to smart contracts is that they can be used for illegal purposes. Smart contracts on a given blockchain tend to have uniform terms. It is possible that a blockchain could be set up where by one party agrees to pay for fraudulent information or murder in exchange for value. The process of paying for illegal services could be streamlined through smart contracts.
Even in light of smart contract’s negatives, the software can be improved and has the potential to improve contracts going into the future. Smart contracts offer the ability to streamline the performance of agreements by reducing the amount of intermediaries necessary to fulfill transactions. This increases the speed of a transaction, cut costs, and promote predictable results. The major hurdle will be finding lawyers who understand the underlying code.