The blockchain technology is not only disrupting the banking, healthcare, education, agriculture and healthcare industry, but also the legal industry. Many industries are finding new ways to adopt this technology every day. The blockchain technology boasts of a trust system, whereby trust is established through collaboration and code, rather than a central authority. Smart contracts are a product of this technology. One benefit of these smart contracts is that it reduces the reliance on trusted intermediaries unlike in a traditional contract law.
A contract formalizes an agreement between two or more parties. A contract refers to an agreement between two parties creating a legal obligation for both parties to perform certain tasks. There are three most important things needed to carry out a contract: An offer, an acceptance of the offer and a consideration. A contract becomes enforceable when two parties exchange something of value. E.g. a consideration*. The problem with the traditional contract law is that one party might not trust the other party. Smart contracts eliminate any trust concerns, because you would not need to trust the other party, but the smart contract itself.
The term smart contract was coined and first proposed by Nick Szarbo who is a computer scientist, legal scholar and cryptographer. A smart contract is a special computer protocol or lines of code that are intended to regulate or execute the terms of a contract . The aim of smart contracts is to improve the traditional contract law, provide security using cryptography and to reduce other transaction costs. Creating a smart contract requires: digital signatures of all participants to the contract, subject of the contract and contract terms. All these are used on the decentralised platform.
A perfect example of a smart contract is the “vending machine example”. The vending machine shares the same properties as a smart contract. Vending machines are governed by a set of rules which define what happens when certain conditions are met. Let’s assume we have a vending machine with different types of cans of drinks and their various prices. If you put the exact amount it costs for a cola drink, then you’ll receive your can of cola drink. If no coins are inserted, no cola drink comes out. What has happened here is that, the vending machine only executes the instructions given to it.
Comparing it to the smart contract, a smart contract is governed by contract terms. These terms are coded and put into a block of a blockchain. The contract is then distributed and copied among the nodes and made visible to all parties of the contract on the blockchain. Once a triggering event such as an expiration date is hit, the contract is performed in accordance with the contract terms and executes itself. Taking another popular example of Bob and Alice. Bob being the seller and Alice a buyer. Bob wants to sell his car so he identifies himself with a blockchain address and uses a smart contact to define the terms of trade, stating that “If a particular amount is sent to my account number, then automatically transfer car identification as well as grant smart lock access to the sender”. Bob then leaves his car which also has a blockchain address in a garage with a smart lock which is activated by the terms given in the contract. Alice, who is the buyer, is in dire need of a new car and finds Bob’s car listed. She checks the smart contract and signs it with her private key. Immediately, the cost of the car is transferred from Alice’s blockchain address to Bob’s address. The smart contract is then verified by each node checking if Bob is the legitimate owner of the car and if Alice, the buyer has the required funds to complete the transaction. If the network is able to verify that all the conditions of the contract are met, then the access code is released to Alice to gain access to the smart lock. Bob in turn gets his money and Alice can now pick up her car using her private key. The transaction is completed.
One of the main issues with smart contract is Dispute Resolution. Cryptography experts are deploying new ways to settle disputes in a smart contract. There are decentralised dispute resolution platforms. An example of these are Code Legit–Codelegit Certified Blockchain Arbitration Library, JUR, Sagewise etc. In order for disputes to be resolved in a smart contract, there are some mechanism that has to be in place ( R3 and Norton Rose Fulbright);
- A provision in the contract code that causes delegation to an arbitrator, which would be triggered under rules encoded in the smart contract
- A provision in the contract natural language version agreeing to submit disputes to arbitration
- A forum for arbitration, which could be administered centrally, or via a relevant ledger, or by use of one of the many existing and experienced fora. The forum would identify these essential components:
– a body of rules for the arbitration
– pool of possible arbitrators, who could vary from persons able to provide expert determination at a low fee to high-value arbitrators capable of overseeing complex disputes
– an administration capable of managing the cases as they are filed and decided
The development of Smart contracts are becoming more sophisticated in order to accommodate complex transactions and complex contractual agreements in a few years.
Use Cases of Smart Contracts
Apart from trade finance, smart contracts can be used in a number of ways such as land registry, supply chain and logistics, governance and a lot of other areas. There are a number of real life use cases and testing of smart contracts around the world. An example of smart contract in Africa is the Bitmari project which is yet to be launched. They plan to develop an application using smart contracts, that allows buyers to purchase farming contracts for agricultural projects in Zimbabwe to aid agricultural funding.
Advantages and Disadvantages of Smart Contracts Over Lawyers
Smart contracts remove the intermediaries and cost of the intermediaries from the equation. There has been a number of conversations as to whether smart contracts should be included in the traditional legal system or whether they can replace lawyers. This is because a lot of business contracts are too detailed, cumbersome and contain legal jargons. They require people who understand legal terms to decode them. This has made smart contracts a more appealing choice, especially with the removal of lawyers and agency costs.
Another advantage of the smart contract over lawyers is that information put on a Blockchain is difficult to change or alter. Smart contracts automatically execute transactions following predetermined rules and these encrypted records are shared to all the participants of the contract. This makes it difficult for anybody to change the terms for their own benefits. Smart contracts are also self-executing. There’s no need for a third party to verify and validate the terms of an agreement.
However, smart contracts are also not without limitations. The smart contracts being unalterable is both an advantage and a disadvantage . The code of the contract is written by humans and humans can make mistakes. Once there are errors in the codes or there is a bug in the code, someone with a lot of technical skills can use it to his or her own advantage. An example of this is the DAO, where about 3.6million ether was drained from its smart contracts, due to a code vulnerability. Privacy is one of the major issues with smart contracts. There are confidential types of contractual agreements which cannot be left open to the public on the blockchain network. Currently, this is being worked on.
Implementation costs of smart contracts is another limitation for the execution of smart contracts. Smart contracts requires the skills of a programmer, to create and define the terms. It is very essential to have a programmer or coder on the team in order to develop an error free smart contact.
And so, “The reality is, even though we think machines can render contracts effectively, there are lots of situations where they cannot.” — Kevin Werbach. In places where efficiency is needed and digital innovation is encouraged, smart contracts would be embraced rather than old fashioned lawyers with their too detailed and cumbersome contracts. However, legal practitioners will need to take a step further in educating themselves on the issue of smart contracts, in other to understand how some of their work process can change and be automated. They need to understand technological innovations and work closely with tech gurus, so that they too can make their work easier and benefit from the automated process. The pace of technology improvement is notoriously unpredictable, whether smart contracts will replace lawyers depends mainly on technological acceptance.
*Consideration is the benefit that each party receives, or expects to receive when entering into a contract. Consideration is often monetary, but it can be a promise to perform a specific act, or a promise to refrain from doing something.
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