Smart Contracts: Legal Perspectives

By Baha'a Armouti

Smart contracts are digital contracts that can execute themselves. Unlike its conventional counterpart, this type of contract runs automatically as per the pre-defined rules. Smart contracts are based on blockchain technology, and it is an ideal solution for businesses that require trust in the execution of contracts. Smart contracts are perfect for anyone or any business that needs to reduce the cost and time spent on administration whilst ensuring a much higher trust between parties involved. This blog post explains smart contracts, their potential uses beyond cryptocurrency transactions, and how they work.
What is a Smart Contract? 
A smart contract is a computer protocol intended to digitally facilitate, verify, or implement the terms of a contract. Smart contracts are autonomous computer programs executed when a particular condition is met. The conditions can be written into the contract or triggered by an event or a state change. 

The outcome of the process almost always depends on a blockchain, although other distributed ledgers can also be used. Smart contracts are programmed into the blockchain network. The blockchain network is a combination of computers used to verify transactions using a “proof of work” algorithm. The blockchain network is like a shared ledger distributed across computers, which means it is decentralised and public. Anyone can access the blockchain to see the transactions that have occurred, but the identity of the people behind each transaction is completely private.
How do smart contracts work?
Smart contracts are computer protocols that facilitate, verify, or enforce the terms of a contractual agreement. They are programmed to execute the specific tasks outlined in the contract, like transferring the payment, transferring the title, or storing data. A smart contract can be compared to a vending machine. For example, suppose you want to sell your old car to a friend. You and your friend are willing to use a smart contract to facilitate and verify the terms of the sale. You can set up a contract on a blockchain network. This contract will have terms like the name of the car, the buyer's name, the price of the car, etc. The contract will have a function that allows the buyer to transfer the payment to you through the network, ensuring the payment is made. It will also have a process that enables the seller to transfer the title to the buyer through the network, ensuring the title of the car is transferred. 
Benefits of using smart contracts 
Trust: Unlike a conventional contract, a smart contract is 100% trustworthy. You don’t have to go to court to get justice if someone breaks a smart contract because the smart contract has a built-in mechanism to resolve disputes. 
Speed: Conventional contracts require approvals and signatures that can take days or weeks to complete. Smart contracts complete the same process almost instantaneously because they are automated. 
Reduced risk: If a person or an organisation breaches a conventional contract, there is a chance you will lose money. However, a breach in a smart contract results in the automatic execution of the required corrective action, like returning the funds or transferring the title. 
Cost: Conventional contracts are expensive and time-consuming because they rely on humans to verify and complete the process. Smart contracts are cheaper and faster because they are automated. 
Nature of the Contract: A conventional contract is a promise someone makes, while a smart contract is a promise made by a computer. Also, a conventional contract can be breached by a person, whereas a smart contract can’t be breached by a person. 
Types of Smart Contracts 
Asset-backed: These contracts are backed by assets such as commodities, shares, gold, and real estate. They are used when you are buying or selling an asset. 
Futures: These are contracts to buy or sell an asset at a particular price on a future date. Futures contracts are often used in commodities, currencies, and equities. 
Cryptocurrency: These are smart contracts used to facilitate crypto-to-crypto transactions.
Insurance: These are insurance policies automatically executed if a particular event occurs.
Security: These contracts are used in the sale of shares by companies.
Supply chain: These are contracts used to track and verify the movement of goods from the source.
Token: These are digital tokens that can be used instead of a cryptocurrency.
Trust: These are escrow accounts held by a third party to ensure all parties abide by the contract. 
Downsides of Smart Contracts.
Security: Since smart contracts reside on the blockchain network, which is publicly accessible, they are prone to security breaches.
Legal: Smart contracts can’t be used in all jurisdictions because laws differ from country to country.
Code: A single error in the code can halt the entire contract, which might not be desirable under certain conditions.
Trust: A smart contract can’t be trusted 100% because it is programmed by humans, who have biases and subjective judgements.
Language: The contract must be written in a programming language that the blockchain network understands.

Examples of Smart Contracts in Law and Business

There are many possible applications for smart contracts in law and business, including but not limited to the following examples:
Loan Contract: A bank uses a smart contract to issue a loan to a borrower. The smart contract automatically deposits the loan amount in the borrower's bank account and debits the amount from the bank. In addition, the interest rate and monthly payment terms are programmed into the contract. The contract terminates if either party defaults.
Parking Contract: A driver pays a parking lot attendant using a smartphone app to buy a parking contract. The contract specifies the duration of the parking period and the amount due. If the driver is over the time limit, the amount to extend the contract is automatically debited from the driver's account. If the driver returns during the allotted time, the payment is credited back to the driver.
Futures Contract - A farmer and an importer sign a smart contract to sell soybeans. The price of soybeans is programmed into the contract, and the importer's payment is automatically transferred to the farmer's account, as is the payment from the buyer.
Franchise Contract: A franchisee and a franchisor sign a smart contract to run a franchise. The franchisee's monthly fee is programmed into the contract, and the amount is automatically transferred to the franchisor's account.
Real Estate Contract - A seller and a buyer sign a smart contract to exchange the seller's real estate property for the buyer's payment. The amount to be transferred from seller to buyer is programmed into the contract when the property is transferred to the buyer.
Crowdfunding Contract: An entrepreneur and backers sign a smart contract to fund a product development project. The funds pledged by backers are programmed into the contract, and the amount is automatically transferred to the entrepreneur.
Joint Venture Contract - Two business partners sign a smart contract to enter into a joint venture. The amount to be contributed by each partner is programmed into the contract. The contract terminates if one partner defaults.
Smart Insurance Contract - A policyholder and an insurer sign a smart contract to provide coverage for a natural disaster. The amount to be paid to the policyholder is programmed into the contract. The contract terminates if either party defaults. 
How Legal Industry Professionals Can Prepare for Smart Contracts 
Legal industry professionals can prepare for the advent of smart contracts by learning about this technology, familiarizing themselves with relevant legal issues, and developing an approach to these new challenges. Here are some ways to prepare:
- Learn about smart contracts - Learn about smart contracts and the benefits they offer in contracting. Explore the technology behind them and how they differ from traditional contracts. - Explore legal issues related to smart contracts - Understand the implications of smart contracts in your industry and how they can be used to accelerate inefficiencies and reduce costs. Be familiar with the legal issues related to smart contracts, such as whether they are legally binding, privacy concerns, and implications for existing laws and regulations. - Develop an approach to smart contracts - Build an understanding of how smart contracts might be used in your industry and how you can prepare your organization for this technology. Explore ways in which current business practices might be transformed by smart contracting and how you can participate in this evolution. - Prepare the next generation of legal experts - Work with law schools and legal education providers to introduce smart contracting and the legal implications of this technology to future legal professionals.
The use of smart contracts is growing, and they are likely to become more widespread as the technology behind them becomes more reliable. Although there are some challenges to implementing them, the benefits are clear. By reducing the need for trust, they can help to make business transactions more efficient and cheaper. 
They can also make it easier to do business with people who you don’t fully trust, such as partners or suppliers in other countries. Smart contracts are likely to become more common as technology improves and people become more familiar with them. They could be used in many different areas, from supply chains to financial transactions. 

 Copyright © 2022, Al Armouti Lawyers & Consultants. All Rights Reserved.Disclaimer: The information provided here is of a general nature and may not apply to any particular matter. It does not constitute legal advice nor presumed indefinitely up to date.  

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