Smart Contracts: Navigating the future of contracting with codes and nodes
Smart Contracts: Navigating the future of contracting with codes and nodes

In February 2019, Italy became the first country to recognize Distributed Ledger Technologies, and the legality of smart contracts. In effect, DLTs are now admissible as evidence in legal proceedings and smart contracts are accepted as an efficient system to carry out end-to-end commercial transactions across several countries worldwide.

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The emergence of blockchain technology has been instrumental in the creation of contract platform that is safe, immutable and secure, called smart contracts. Though still at its nascent stage, the use of bitcoins and cryptocurrencies have led to the use of smart contracts at organizational level, particularly in the Fintech services. In certain jurisdictions, however, the use has rather been limited due to regulatory and legislative concerns looming over the cryptocurrency, or virtual currency that is used as “quid pro quo” element in smart contracts. In what follows, we look into the broader aspects of smart contracts, and its ability to change the legal service delivery system in the future.

By the very definition: The distributed, decentralized ledger system

Smart contracts are self-executing, block-chain-enabled contracts built on peer-to-peer distributed ledgers running on two central premises: Contracts and Currency (Ethereum). They were first introduced by computer scientist and cryptographer Nick Szabo in the early 1990s who wanted to create a system for formalizing relationships with contracts. In principle, smart contracts work on a set of codes with pre-determined rules that work on the premise of "If this, then that". Hence, once the pre-conditions are met, then the desired transaction will be carried out.

The immutable pieces of codes that run on virtual machines have emerged as a faster, efficient, and seamless way to execute contracts, devoid of human agency, errors, or ergo. In sharp contrast to the traditional arrangements, smart contracts are self-executing, cannot be modified, or tampered as it restricts human participation to a considerable extent.

According to Accenture 2017 research, investment banks alone may stand to save upto $12 billion per year by adopting block chain and smart contracts.

Gartner estimates that 25% of the global organizations will be using smart contracts in their systems by the year 2022.

Based on a survey, the International Association of Contracts and Commercial Management (IACCM) estimates value erosion of 9% caused as a result of the current contracting processes. Although every pitfall cannot be identified and fixed, even half the total- 4.5% can translate to significant cost savings.

Emerging role of Blockchain Technology and Contract enforceability

Smart contracts have, in a way, the ability to drive efficiency, mandate compliances, and streamline processes for any legal department. When combined with contracts' electronic execution, it can open doors to complete and end-to-end automation and digitization of agreements, thereby saving costs and creating opportunities compared to formal written agreements. Russian CEO, co-founder of Jincor, notes, "companies can establish business relations, streamline contractual and legal procedures via smart contracts and conduct cryptocurrency transactions safely and easily."

While smart contracts can conduct transactions that impose fine/penalty where contractual obligations are unmet, they by default, can also ensure that the contractual obligations are met-all without human agency intervention or judicial procedures.

Decentralization of Contracts

Due to the nature of extensive coding and the obfuscated structure, blockchain technology has certain limitations and restrictions for individual use. So do the smart contracts.

While smart contracts can conduct transactions that impose fine/penalty where contractual obligations are unmet, they by default, can also ensure that the contractual obligations are met-all without human agency intervention or judicial procedures.

  • By the very nature of its conduct, smart contracts are immutable, which makes it imperative to have all the legal clauses in place before the final execution of contracts.
  • The highly decentralized nature of smart contracts makes it difficult to carry out amendments and rescission of contracts by the end-user alone.
  • Transactions once made cannot be altered or reversed without validation by specific codes and nodes.
  • The requirement of proportionate consideration is a highly debated issue surrounding smart contracts. The legality and the object of consideration is a critical component.
  • Individual security concerns may arise due to the involvement of cross-functional expertise, including technologists, coders.

What remains a major challenge till date is the application of smart contracts with cryptocurrency. Switzerland, Italy, US have been the pioneers in adopting Blockchain for commercial transactions, while countries such as India, China, have restricted the activity of cryptocurrency to a large extent. A comprehensive assistance and evaluation, by having in place a regulatory sandbox is a proposed initiative in several countries. In first of its kind, the Financial Conduct Authority (FCA) of UK has established first regulatory sandbox to look into the loopholes in the market. With regulatory sandboxes being safe zones to carry out developments especially in the fintech sector, they can be beneficial in devising regulatory frameworks to address and cover issues pertaining to smart contracts.

While the widespread application and use of smart contracts is unquestionable, its merits seem to define and refine the future of contract management. In all certainty, smart contracts can overhaul contracting processes and ensure contracts' seamless execution at every stage. Since the use of cryptocurrency is still vague across various jurisdictions, what lies ahead for smart contracts is the regulatory bodies' decision to include them as a part of the regulatory sandbox and devise appropriate frameworks to address these shortcomings in smart contracts.