With the rise of automation has come many useful technologies. Smart contracts, or self-executing contracts, are one such technology. These contracts have a range of applications and uses across different types of businesses. So, what are smart contracts? How can smart contracts benefit you or your business?
A. What are Smart Contracts?
Smart contracts are a form of agreement which comprise the capability to automatically execute, calculate and enforce elements of the agreement. They work on the basis of the blockchain, a decentralised ledger, being converted and managed by computer code and software programs. This computer-based facility allows for the storing, replication, conversion and transfer of contractual details without human intervention. In this way, it is a highly efficient and transparent means of conducting contractual dealings. They are also extremely versatile, capable of being used to exchange anything of value, including but not limited to money, property and shares. Additionally, this method avoids the use of a ‘middle-man’, which is cost effective and avoids potential conflict.
B. How do Smart Contracts Work in Practice?
Smart contracts were originally designed by Nick Szabo, a computer scientist and legal scholar, in the 1990’s. In his paper The Idea of Smart Contracts, he analogised the processes involved in smart contracts to those involved in standard vending machines. This machine, when provided with a specific input data or value (here, it would be money) by the user, presents a particular item or good from the machine (e.g. a drink). That is, the ownership of the item or good is transferred to the user. The contractual dealings involved in vending machines can, under this example, be described as machine-facilitated or machine-enabled contracts, capable of regulating and holding the relevant items or goods in order to enforce the contract with the user. Smart contracts work the same way, but use computer code to facilitate the transaction. For instance, a smart contract could transfer the ownership of property, with computer code triggering the exchange.
C. Limitations of Smart Contracts
This technology is not without its limitations. A smart contract will execute exactly as it programed, and so may not be as flexible or practical in the context of more complex contractual dealings. Human judgment is still vital in contractual matters involving unpredictable issues or risk, such as dealings which concern the financial marketplace. That is, certain issues are not necessarily quantifiable or will fall within the scope of what has been programmed. There is still clearly considerable ground to cover in terms of boosting confidence in the smart contract and blockchain systems. Further issues regard security, privacy and lack of regulation. Nevertheless, it is completely possible that over time, and with further research, these technologies will become commonplace and instrumental to day-to-day contractual matters. It is hoped the law works quickly to address governance issues.
Smart contracts are an increasingly popular and useful technology. It ought to be kept in mind that the utility of this technology is, at this point in time, best confined to simple contractual matters rather than complex dealings that require discretion.
If you need any advice about incorporating smart contracts into your business model or with addressing their limitations please get in touch today! For more information about contemporary contractual issues check out our Resource Centre.
This article was authorised by Warwick Heeson.