We have all heard about ‘smart contracts’ for quite some time. The tech industry has been getting very excited about the capabilities of this software, however, is this anything new? Is it the way forward? Or is it still a long way off from having any real impact in sectors beyond tech?

What is it?

The phrase “smart contracts” was coined by a US scientist (Nick Szabo) in 1994 (yes, 25 years ago!). A smart contract is not a contract in the traditional sense. It is a self-executing contract which requires little or no human intervention to activate or enforce performance. A widely used example is a vending machine. However, smart contracts today have an added dimension – blockchain.

Blockchain is the word on everyone’s lips at present: those who work with it, those who want to work with it, and those who are praying that they won’t have to! At a very basic level, blockchain is a form of digital ledger technology (DLT) and is stored across a network of computers. Data is stored in blocks and is then linked together (hence blockchain).

Incorporating blockchain into a smart contract involves coding the contract into data blocks. The magic then happens due to the chain of data that is created. If a transaction or an event has an impact on the contract, it is automatically recorded and managed by blockchain, so any outcomes can occur automatically without human interference. For example, using a smart contract in a manufacturing context will mean that payment for the production of a consignment of goods will be automatically triggered once that specific requirement of the contract has been met i.e. delivery at a certain depot, as opposed to waiting for an invoice to be generated at the end of the month and then waiting a further 30- 90 days for payment.  

Is it the way forward?

Yes but there is a ‘but’.  It is certainly the way forward for relatively simple contracts that can be coded and executed automatically once pre-conditions have been met e.g. in residential conveyancing where completion monies can be released as soon as contracts are signed. Smart contracts will save businesses globally a significant amount of time and money and will radically change the way that they interact with one another in the supply chain, and with their consumers. There will be limited human interaction which will free up individuals and key decision makers from dealing with routine administration and red tape, enabling them to get on with the day job as the smart contract automatically takes up the slack.

Furthermore smart contracts eradicate the need for trust within business relationships. Neither party will control the contract so any commercial fears will cease to play a part. Events will be monitored and triggered automatically by blockchain. Because a smart contract creates a digital relationship between the parties to the contract, it also means that any updates are recorded in real time, avoiding the danger of multiple iterations being in circulation at any one time.

Whilst I do think this technology will disrupt the way in which business is conducted, I do not think that smart contracts will completely take over. For example, some contracts require a subjective trigger. This is best illustrated in the engineering and design industry. Whilst automated systems and machines can already calculate, calibrate and even manufacture products, the system cannot confirm a subjective element of a contract i.e. whether the product has captured a designer’s or customer’s vision for the product. A machine will be able to ascertain whether it has been made to specification, but a machine can only make determinations based on the information or code that has been inputted.

As with any new disruptive technology, there are hurdles that need to be overcome. In order to create the infrastructure for smart contracts to thrive, implementation costs are likely to be significant. Cyber security and maintenance will also make up a large proportion of costs. Whilst the DLT is generally considered safe, smart contracts will have to operate over an open public ledger due to the nature of blockchain. Although it is decentralised, as with anything operating over a vast network, it is vulnerable to cyber bugs and hackers.

How long have we got?

A number of banks and insurance companies are already using smart contracts in their day to day businesses. Therefore, smart contracts are already here and are being tested in real life circumstances, so it will not be long before we see them form part of our daily lives and routines.

Notwithstanding the above, there is a long way to go before everything will be governed by a smart contract, if at all.  Given that I am a litigator, I cannot help but wonder how we will arrive at a position where blockchain will be able to determine whether the parties had the intention to be legally bound, or whether one party has entered the smart contract under duress. Whilst I fully understand and appreciate that smart contracts will self-perform and self-enforce,  I do not see how smart contracts will solve interpretation issues, given the number of breach of contract cases I have litigated over, unless our legal language or methods of negotiation change. Who knows: perhaps smart contracts and DLT will set a legal precedent for their governance in their own right.

This article first appeared in the July/August 2019 edition of Engineering Designer magazine.

About the author

Tariva Thomas Associate

Tariva is a member of the Tax and Financial Services Litigation team dealing with disputes relating to investments, tax avoidance schemes and pensions. Tariva advises corporates, individuals, financial institutions and FCA regulated firms.