Smart contracts

by Dentons


What is smart technology?

All technology is equal, but some technology is more equal than others. "Smart" technology is a term used to describe devices and systems that are capable of adapting and modifying their behaviour to fit their environment. They sit in contrast to "dumb" technology, i.e. tools that need human interaction to function.

We are becoming more familiar with smart technology as part of our home ecosystems. But what if it can be used to improve things that we don’t consider "dumb"? What if it can augment a commercial contract – something which is usually the product of significant human drafting and negotiation? To understand how technology might change the way in which we contract, we need first to explore blockchain technology. It's most commonly associated with Bitcoin but the secure and public network that it provides can be used for other purposes.

How does the blockchain work?

The blockchain is a digital and "incorruptible" ledger that maintains a public record of data transmissions between individuals. Referring back to Bitcoin is probably the neatest way of describing how blockchain technology works. Anyone can join the Bitcoin network by creating a public key that connects them to the network, as well as a private key to identify themselves. When a user wants to transfer Bitcoin to another individual (the recipient), he does so by sending a message to the network, tagging it with both the recipient's public key and the amount that he wants to transfer. He also signs the message with his private key for identification.

The network checks his account to make sure that he has enough Bitcoin to make the transaction and, once confirming that he does, effects the transaction. The data transmission (effectively, a payment) is logged on the ledger, which is "distributable" (that is, replicated on each user's device). This is what makes the network fully public and, accordingly, incorruptible – it is constantly being "witnessed" by those within the blockchain community.

And how does this tie in with smart contracts?

For lawyers, the most interesting observation arising from this example is that blockchain technology allows for "checking" of a condition precedent (specifically, whether the user has enough Bitcoin to effect the transaction). Typically, performance of a commercial contract is managed by the parties or, if something goes wrong, external regulators like courts and arbitrators. It can be a long and costly process, and involve significant argument over what the terms of a contract really mean.

Smart contracts are, essentially, a "set of promises" between parties, which have been converted into computer code. They operate on the premise that "if X happens, then do Y" – which makes them ideal for certain kinds of obligations. If we take a rental agreement as an example, there is a clear benefit if a contract automatically issues a tenant with the keys to his property as soon as he pays her deposit. There is no need for a third party (such as a real estate agent) or even the landlord to confirm that payment has been made and, potentially, slow the process down for both parties.

Being part of a public ledger, smart contracts are, potentially, also more transparent. While documents evidencing the performance of a "dumb" contract can be lost or disputed, any ledger of smart transactions (if based on blockchain technology) is "distributed", i.e. replicated in full on each user's device. This creates a robust evidence trail if there is ever a dispute. In the previous example, the transparent nature of the rental agreement also allows other prospective tenants to access contract terms and prices.

There is also the possibility of typing smart contracts to other technologies. For example, the installation of a smart device (such as an energy meter) within a household will accurately measure that household's energy usage and calculate its energy bill accordingly. If the device was paid for under a smart contract, there might be no need for a separate billing process – any energy measurement would automatically trigger payments at the end of the month.

Can smart contracts replace lawyers altogether?

The simple answer is no – at least not at this stage. While smart contracts can regulate simple transactions (especially those elements of the transaction which impose payment or similarly binary triggers), there are many complexities of contracting which are not adequately addressed by smart contracts. Some of these complexities are deliberate, in that they deliberately reflect compromises and bargaining positions reached between the parties. For example, a landlord typically allows for a tenant's "reasonable wear and tear" but requires compensation for "major damage". It is difficult to see how code could distinguish between the two concepts, as well as other nebulous ideas such as "good faith", "reasonable care and skill" or "reasonable endeavours".

Issues of contract formation also need to be considered. To be valid, a contract needs (among other things) to have certainty and for its parties to have intended to enter into legal relations with one another. It's unclear as to whether this would necessarily be the case when a contract was formed between strangers, with major terms being expressed in code that is not readable by humans. These points suggest that blockchain technology could certainly contribute to the effective operation of commercial agreements, but that they are not quite standalone yet.


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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