For most of us, blockchain technology is associated only with cryptocurrencies, such as Bitcoin or Etherium. However, this technology is far more powerful and valuable. It is already impacting many sectors, including legal agreements.
The next big thing in the legal realm is smart contracts based on blockchain technology.
What is blockchain?
A blockchain is essentially a digital ledger of transactions that is duplicated and distributed across the entire network of computer systems on the blockchain. Each block in the chain contains a number of transactions, and every time a new transaction occurs on the blockchain, a record of that transaction is added to every participant’s ledger. The decentralised database managed by multiple participants is known as Distributed Ledger Technology (DLT). Blockchain is a type of DLT in which transactions are recorded with an immutable cryptographic signature called a hash.
Source: Euromoney
Smart contracts are not only about how we sign documents but also about new ways to execute contracts.
What Is A Smart Contract?
A smart contract is an agreement that consists of contractual clauses stored in a blockchain, enabling self-execution and self-enforcement of an agreement. In other words, a smart contract is some sort of computer program that automatically executes terms and conditions according to the rules set out in a program code. The most simple example of such code is
“if the goods are delivered, then the money shall be transferred”.
Smart contracts are self-sustainable. Since the contract is signed, it is unnecessary to monitor its execution or hire any intermediaries. The rules inside a blockchain will monitor execution, record the progress of the execution, and trigger further actions according to the predefined rules.
Smart contracts may be beneficial in various sectors. For instance:
Mortgage loans
The process of entering into a mortgage loan is complex and consists of many steps (e.g. property value evaluation, assessment of creditworthiness, verification of documents, mortgage of property, etc.). Smart contracts can facilitate this process by eliminating manual jobs and automating the entire process.
Financial industry
Smart contracts can automate payments, clearing, trading and many other processes. For example, the onboarding of clients can be done by using such contracts. A client fills in the requested application, submits it to a financial institution, automated rules inside a blockchain application verify and collect information and automatically conclude an agreement between the client and the bank by accepting the application or rejecting it. The best thing is that all and any information collected is recorded and stored inside a smart contract.
What Are The Benefits Of Smart Contracts?
Anonymity
Smart contracts can revolutionize the conclusion of contracts. For now, it is literally impossible and unlawful to enter into an agreement without revealing contracting parties. Data on contracting parties is a must in each contract. Without such data, a contract cannot be executed and is not enforceable.
Blockchain technology enables the conclusion of contracts without revealing the contracting parties. Such contracts will be executable even without knowing who entered into this contract. However, such a unique feature of smart contracts cannot be used now. An agreement with concealed parties will not be enforceable because existing legal regulation obliges to reveal contracting parties.
Cost savings
Traditional contracts consist of many clauses which can be interpreted in different ways by different people, including, lawyers. It’s hardly possible to draft and fully understand a traditional contract without the assistance of lawyers whose hours are very expensive. Smart contracts can be prepared without the involvement of lawyers.
Transparency and Accuracy
Provisions of smart contracts are codified and function as a program. The outcomes of such a program can be easily verified. Smart contracts automatically perform transactions following predetermined rules. All information related to the performance of a contract is recorded inside a blockchain. Therefore, once a smart contract has been concluded, one might be sure of what he can expect from the contract and to be sure that his rights will be protected in case of failure to perform a contract. Contrary to traditional contracts, there is no way for different interpretations of the same clauses. Coded clauses of smart contracts can be executed only in one predefined way.
Security
Smart contracts are based on blockchain technology, which makes them very difficult to hack. Smart contracts are safer than contracts signed with wet signatures or electronic signatures.
Speed
Smart contracts can be drafted quicker than traditional ones because algorithms and special software do the entire process.
What Are The Downsides Of Smart Contracts?
Security issues
Smart contracts are created and stored in platforms available through the Internet. That can cause confidentiality issues because such platforms will always be vulnerable to hackers’ attacks.
Reliance on “black boxes”
Standard contracts can be read and understood by many. Smart contracts are black boxes where the magic happens, and special knowledge and special tools are required to understand what is inside such boxes and whether they function as they should be. Reliance on experts and special tools can be costly and be a reason for fraud.
Regulatory challenges
Currently, no special laws have been adopted to regulate smart contracts. Regulation will either boost the usage or create conditions under which hardly anyone will be willing to use such contracts. Until the arrival of such regulation, it is impossible to predict its shape and essence.
How To Create Smart Contracts?
The drafting of smart contracts is performed in two stages:
- The parties agree on terms and conditions.
- Special software converts the agreed terms and conditions into a programming language.
Drafting of hard (paper) contracts can be done without intermediaries by yourself (of course, the knowledge of legal stuff is required). A signing process also doesn’t require the involvement of any intermediaries. Smart contracts are a different story. Smart contracts are computer programs that cannot be concluded without special software (systems) designed to create a blockchain.
For now, smart contracts are just in the initial stage of their development; however, due to the enormous popularity of blockchain technology and all that hype around it, many companies believe in the bright future of this technology:
Ethereum
Ethereum is one of the oldest and the most advanced platform for coding and processing smart contracts. For most people, Ethereum is known as a cryptocurrency that is second to Bitcoin in market capitalization.
Cardano
Cardano is an open-source and decentralized blockchain platform. It can facilitate peer-to-peer transactions with its internal cryptocurrency, Ada. Cardano was founded in 2015 by Ethereum co-founder Charles Hoskinson. Cardano is developing smart contracts under the project “Goguen”. One of the goals for the Goguen is the creation of Plutus, a purpose-built smart contract development language and execution platform using the functional programming language Haskell. Plutus is already available for testing and brings the benefits of functional programming to smart contract creation. It also allows one code base to support both on and off-chain components, improving the coherency and usability of the development experience compared with existing smart contract implementations.
Stellar
Stellar, or Stellar Lumens, is an open-source, decentralized protocol for digital currency to fiat money low-cost transfers which allows cross-border transactions between any pair of currencies. It offers a simple solution that does not require coding knowledge to create smart contracts.
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Images from Pixabay.
