Can Smart Contracts Really be Smart?

by Field Law

Field Law

We are in the midst of a revolution – a revolution in the technology of storing, processing, and communicating information… [which] has brought about profound changes in business, political, and social institutions.”

This quote sounds like it resonates today. We are in the midst of an endless stream of developments in hardware, software and computing power that has pushed artificial intelligence (AI), blockchain and smart contracts into the mainstream. The fact that this quote comes from a 1990 article – almost 30 years ago, when the internet was a primordial swamp compared to today – shows something. It shows that societal feelings of being overwhelmed by technological change are not new. We are constantly waking up to a sense that yesterday was somehow simpler, more stable and easier to understand, and tomorrow is more complex, more uncertain, fraught with both risk and opportunity.

The use of so-called “smart contracts” has been slowly developing for many years. With the confluence of blockchain technology and artificial intelligence (AI), there has been a recent surge in interest.

1. What is a “smart contract”?

The term suggests that so-called smart contracts will ultimately replace traditional paper contracts through the use of some computer-driven wizardry. Not so fast. The term “smart contract” does not have any special meaning in the legal sense – what we’re really talking about are transactions or workflows that are implemented with software.

One commentator has suggested an alternate name for smart contracts, saying “They're neither smart, nor contracts. Instead, I suggest the term "programmatically executed transactions"… ” or PETs. Essentially, software can be programmed to automatically execute a certain series of agreed-upon steps and transactions, taking the process out of the hands of humans, and placing these steps into the hands of a machine.

One simple example of a smart contract is a common vending machine. The user transacts business by means of an input (say, a toonie) and the machine is programmed to execute a transaction automatically by releasing the output (say, a can of cola) on satisfaction of certain conditions.

This can be extrapolated with more complex software, more varied inputs and outputs, and the addition of blockchain technology, leading to a broad range of possible applications. It’s important to note that this type of computer-implemented transaction process is not dependent on blockchain technology or AI. In fact, there are many examples of successful deployments of transactions where software has automated segments of the workflow. As an example, look at Apple’s popular iTunes or App Store ecosystem. The ability to use this system to rent a movie is driven by software-implemented payment processing, content licensing, digital-rights-management, and time-stamped encrypted digital downloads which automatically expire after a certain number of days. All of this occurs with very little human interaction or discretion.

2. Are “smart contracts” enforceable?

To get the answer to this question, we can look back at traditional contract law principles. The law in Canada has adapted to allow for electronic contracting, and case-law has adapted to new technological issues over time. Assuming the basic components of a contract are satisfied – offer and acceptance, consideration, and clarity as to the terms of the agreement – then a smart contract can certainly create legally-binding rights and obligations. Under the Canadian legal system the enforceability of any contract will be measured by those factors for the foreseeable future. The use of software to implement an agreement, or to automate the steps for an agreement to be completed, is simply one stage within that evolution.

3. How smart are smart contracts?

To borrow another quote, “smart is as smart does.”

Computer-driven wizardry does not create itself…at least, not yet. The software that drives the automation of any process – from the simple vending machine to more complex transaction processing systems – requires human designers. As with any software-implemented process, the degree of “smartness” is tied to the ability of the human programmer to instruct the computer to carry out certain defined processes, within certain parameters. Anyone who uses software will have an opinion on how “smart” software can be.

This leads to the view that such software is neither “smart” nor “contract”, since it merely automates what it has been told to automate. It’s an algorithm to complete a defined procedure. To apply our earlier example, let’s say a vending machine is stocked by a human operator. The machine is programmed to automatically deliver a certain product when the button “G-4 “is selected by the user, and payment has been processed. If location “G-4” in the vending machine has been incorrectly stocked by the human operator with cola brand X instead of cola brand Y, then the machine will have correctly completed its function, in the sense that it delivered the product located at “G-4”. The “smart contract” has been fulfilled – but from the user’s perspective, the wrong product was delivered.

In other words, the degree of reliability, security and efficiency of a computer-implemented transaction process will be dependent on a range of variables, including human operators, other interdependent computer systems, “last-mile” gaps, variables in inputs and outputs, and environmental factors.

As this area matures, we will learn more. A recent article from the MIT Technology Review warns that security researchers are just beginning to appreciate what smart-contract vulnerability even looks like. This sounds familiar, as we know from the well-documented vulnerabilities associated with data storage, home security, unencrypted email, privacy…or say, the entire federal electoral system.

4. When should smart contracts be used?

Time will tell how pervasive this technology becomes. For the business owner and the business lawyer, it’s important to ask what is the best use-case for smart contract technology? Does it make sense for your business, and if so, how?

Not every transactional process will lend itself well to a smart contract or “programmatically executed transaction”. Some transaction types will be perfect candidates: such as transactions in mature industries which are high volume, highly commodified and predictable, or transactions which involve tasks at which machines excel and humans are inefficient. For example, Calgary’s Guild One has a developed a blockchain-based smart-contract tool called Royalty Ledger which calculates and processes payments owing by producers to royalty owners in the oil and gas industry. Quickly performing complex math and automating payment distribution plays well to the core competencies of machines.

Other areas may be good candidates for a hybrid approach – in fact, the Guild One product could be described as a hybrid solution in the sense that the underlying agreement between producers and royalty owners will be based on a traditional contract, and the day-to-day implementation of that underlying agreement can be automated using a smart contract software tool.

Other transaction types will not be well suited to software automation. In the near-term, I don’t expect software to handle highly customized agreements involving complex human-to-human negotiations.

Based on history, there’s a very good argument that the core competencies of machines will expand with advancements in hardware, software and computing power. If you need a good example of this, have a read of this charming article in the New York Times from October, 1967, which observes that some scientists believe “the logic and imagination required of a chess player were beyond the capacities of any machine.” That belief was put to rest 30 years later in February 1997, when IBM’s Deep Blue defeated the world chess champion Garry Kasparov.

Until our Kasparov moment in the world of contracts, I would argue that traditional contracts, along with the lawyers and business professionals who help draft them, will continue to play an important role in ordering human affairs.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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