Words by Leonardo Bonello, Partner, Ganado Advocates
The term ‘smart contracts’ has come to the fore very recently and is often used in many discussions relating to blockchain. It may, therefore, be surprising to know that the term has been coined over twenty years ago by computer scientist Nick Szabo.
What are smart contracts?
Smart contracts are self-executing contracts with the terms of the agreement between the parties being directly written into lines of code. In simple terms, a smart contract is a contract drafted in computer code with specific triggers leading to predetermined outcomes. A common example of a smart contract utilised in the blockchain industry can be found in initial coin offerings and token generation events. A prospective purchaser of a coin typically sends the subscription amounts to the address of the smart contract. Most coin offerings will have a minimum subscription amount, below which the offered would be deemed to be unsuccessful. The smart contract would be programmed in such a manner that if the minimum subscription amount is exceeded, the subscription amounts would be transferred to the issuer and become the property of the coin issuer. In such a scenario, the prospective purchaser would receive the coin in return.
On the other hand, if the minimum subscription amount is not exceeded, the smart contract would be programmed in such a way so as to return the funds to the prospective purchaser. In this case, the smart contract would have replicated the role of a registrar in an initial public offering. In line with the principle behind blockchain technology, the smart contract would be removing the need for an intermediary.
The above is just one of many examples of how smart contracts operate in practice. The beauty of the technology is that once the objective conditions are satisfied, the contract ‘self-executes’ without the need for any further action by any of the parties.
Will lawyers become redundant?
Whilst some argue that smart contracts will rid the world of lawyers, it is hard to believe that this will be the case. First of all, lawyers will be needed to help draft or structure a smart contract. It is probable therefore that smart contracts may redefine the role of lawyers and that lawyers need to start thinking more like computer coders.
More importantly, however, smart contracts are best used in specific circumstances where there is an objective trigger and where the possible outcomes are predefined. In the previous coin offering example, there can only be two outcomes – the minimum subscription amount is either achieved or not. Furthermore, those outcomes are triggered by an objective fact – the subscription percentage. Whilst smart contracts offer a very neat solution in such circumstances, they are less useful in relation to legal contracts which contain subjective clauses.
It is quite common to have subjective provisions in contracts. For example, any lease agreement will typically provide for a deposit to be provided to the lessor upon signing of the lease agreement, which deposit would be refundable to the lessee on condition that the no major damages would have been suffered by the property during the lease. The release of the deposit would in such cases be clearly subject to the discretion of the lessor who will review the state of the property and ensure that no damage would be suffered in the interim period.
Computer code cannot replicate the discretion of the lessor to determine whether the requirements for the deposit to be released have been fulfilled or not. To complicate matters further, there are definitely more than two predetermined outcomes in such a scenario. The lessor may choose to keep all of the deposit or release of all of the deposit. The lessor could also choose to refund part, but not all of the deposit. Another option could also be that the lessor would sue the lessee beyond the value of the deposit – and the list goes on.
The bottom line is that smart contracts are definitely a useful tool and their use should be encouraged. There are many industries that can benefit from it such as gaming, insurance, derivatives, trade finance, logistics and many others but smart contracts are not the solution to all legal problems and many will just have to make do with continuing to rely on their lawyer to assist them in their disputes, as daunting as that may sound.