Smart Contracts – the end of the traditional paper contract?

[1] have even mused that smart contracts may mean the end of the commercial lawyer. Being a commercial lawyer myself this caused a moment of mild panic. Some investigation was called for. Here is what I found.
What is a smart contract?
The term smart contract was coined by Nick Szabo who published an article in 1997 with the title ‘Formalising and Securing Relationships on Public Networks’[2], in which he explains how different contractual clauses could be embedded in hardware and software by the use of computer protocols. The human readable terms (the source code) of a contract can be compiled into executable computer code that runs on a network, such as the internet.
What does this mean?
It means that all the parts of a contract which can possibly be executed by a computer programme, can be included in an automated smart contract. No manual monitoring or any action is required from a human.
Let’s look at the example of a simple wager. I make a bet with my friend on the outcome of Saturday’s rugby game and code it into a smart contract. We enter into the agreement by means of our online profiles (or avatars), input the amount we each wager and the details of the publication (in this case a respected online sports bulletin) with which the programme should verify the outcome of the game. The contract provides that our wagers are kept in escrow from the time we conclude the agreement until it is paid out to the winner. We conclude the smart contract online and the programme takes the funds wagered from our respective bank accounts and places it in escrow. As soon as the final result is published, the programme executes the contract and transfers the funds to the winner’s bank account.
Why use any type of contract?
One of the purposes of concluding a written contract has always been to provide certainty. Writing the terms down on paper provides proof of what was agreed and makes it possible for both the parties to the contract – and any third party who reads the contract – to know what the terms are.
Blockchain technology has vastly increased the possibilities for the use of smart contracts. Amongst the most important things to know about this technology, is that it is based on decentralised consensus and provides security and reliability – it records every transaction in a public ledger and cryptography is used to secure the authentication of the source of each transaction. No central database is used to rule transaction validity. The blockchain assures that everybody is seeing the same thing without one side having to trust the other side to be honest, because anything that is in the blockchain is unequivocally validated. Once your smart contract is written to the blockchain it cannot be changed and the record is there forever. It doesn’t get much better than this for record-keeping and certainty.
Another – and probably the most important – significance of smart contracts is that when they are applied, third-party intermediaries are not needed in order to conduct transactions between two (or several) parties. Instead, the parties define and agree on simple (or complex) rules, and they embed them inside the transactions written to the blockchain. This enables an end-to-end resolution that is self-managed between computers that represent the interests of the users. A transaction’s contractual governance between the parties can be verified programmatically via the blockchain, instead of via a central arbitrator, rule maker or gatekeeper.
If the payment obligation in a contract provides for payment with Bitcoin or another cryptocurrency, traditional banks, payment gateways and credit cards would be left out of the transaction completely, and also their associated fees. This could radically decrease the cost of transacting and opens transacting possibilities for the unbanked.
Let’s revisit my example of the rugby wager. My friend and I could make this wager from anywhere in the world directly with each other without intervention from a third party intermediary. There is only one set of terms written in computer code and agreed upon upfront. The external dependencies (the outcome of the rugby game) is fed in via a mutually agreed feed in real time. If we bet in Bitcoin instead of traditional currency, we won’t need a credit card payment or an EFT once the winner is determined. Payment would happen within minutes instead of taking a number of days for funds to clear from one bank to the next and there’s no payment gateways or bank charges, nor exchange rates to consider!
So, is this the end of traditional contracts (and lawyers)?
Not quite. Smart contracts are an evolution of the legal system, not its replacement.
Fully automated and self-enforcing smart contracts could deal with highly complex commercial scenarios, but the code may fail to embed all possible answers to all possible questions and thus may not be able to execute the transaction in unforeseen circumstances. A computer cannot make a value judgement; it can only execute instructions.
Also, who will be responsible for drafting the terms and conditions before it is translated into computer code? Lawyers of course!
What is clear however, is that traditional lawyers will have to venture outside their comfort zone and learn to speak in a language that coders and software architects can understand. Not only will we have to speak both ‘human’ and ‘lawyer’, but now we need to understand ‘nerd’ as well. Our role may shift from adjudicating individual contracts to producing smart contract templates.
[1] http://www.afr.com/technology/blockchain-smart-contracts-to-disrupt-lawyers-20160529-gp6f5e
http://digitalmoneytimes.com/smart-contracts-spell-end-lawyers-intermediaries/
[2] http://firstmonday.org/ojs/index.php/fm/article/view/548/469