Smart contracts are improved types of traditional contracts that utilize blockchain technology. In order to dive deeper into their use cases, let’s ask ourselves, why do people need contracts in the first place? There is a simple answer to this – trust.
By nature, people have a hard time trusting people they do not know well. When hiring new employees, an employer does not know if the employee will perform to their expectations. When renting a bicycle, a store does not know if an individual will ride away with it and never come back. Although we may assume everyone has good intentions, there must exist a method of accountability to the commitments, decisions and agreements they enter.
Clearly specifying the terms of an agreement is a contract in itself, regardless of what form the terms are delivered. In general, there are two main ways contracts can be entered; written down or acknowledged verbally. There is however a difference since in order to enforce a contract, you need to prove its existence first. Proving the existence of a verbal contract is much more difficult as there is usually no physical record of it. Due to this, written contracts hold more weight and are more easily enforceable by law.
Smart contracts improve traditional written contracts because they are enforced by a network of computers and are cheaper to implement. Their existence has the potential to transition traditional paper-based contracts into a universal tool that will automatically enforce the terms of contracts, minimizing the risk of error, and manipulation.
Say you want to sell your car. As a seller, you need to find a buyer and fill out a legal document that acknowledges the transfer of ownership in exchange for a specified amount of money. This transfer is documented through a written agreement and serves as proof of ownership to the buyer.
Regular old contracts work like the following; you would fill out an immense amount of paperwork with a third-party, sign it as a seller, the buyer signs it as a buyer and you pay an absurd amount of fees for someone to mediate the transaction, (typically a lawyer). In order to ensure that the buyer and seller both signed the agreement willingly, a witness is usually present. A witness is useful for evidentiary purposes in case a signer says they did not sign a contract at a later date. Although this seems like a great process, in practice witnesses are often not required and their testimony might not hold. Additionally, verifying that a signature is authentic can be a costly process that requires a forensic handwriting expert to determine if the signature was forged. At times, the “expert” might even be incorrect. The technology available today brings some interesting solutions that can help us mitigate these problems.
For example, electronic signatures are a more effective way to confirm the identity of a signer as they are almost cryptographically impossible to forge. However, with the implementation of smart contracts, the need for a witness is entirely removed, as the contract is written down and stored in a blockchain where thousands of people witness the contract and its execution.
Interestingly, the term smart contract is quite unfortunate since these codes are neither intelligent nor should they be confused with legal agreements. It’s important to note that a smart contract can only be as smart as the people that code it. Also, they have the potential to become legal contracts in case certain conditions are met. However, they shouldn’t be confused with legal contracts that are accepted by law enforcement or courts. In the future, this might change, as many countries are beginning to recognize electronic agreements as an enforceable contract.
For example, Canadian courts have already found clickwrap agreements to be enforceable (entered into by users clicking ‘I agree’ to website terms and conditions). In those cases, courts have held that online contracts can be enforceable, but they should provide sufficient notice so that there is an opportunity to consider and decline the contract. This new area in law faces many unknowns since many transactions on blockchain platforms are entered into pseudonymously, which could give rise to questions as to who the contracting party was (and whether it was capable of entering into a contract). As individuals under 18 are not able to enter into a legally binding agreement, how do you verify a smart contract was signed by someone over the age of majority in their province or territory?
Smart contracts offer numerous advantages, for example, they are capable of tracking performance in real-time consequently bringing tremendous cost savings. Also, compliance and controlling can happen on the fly. To get external information a smart contract may use the help external data provides that will feed it with real-time information at any point they may require it.
The removal of a single witness and the ability to sign using electronic signatures also brings some other benefits. For example, depending on the location of the contract, participants become irrelevant as a smart contract can be witnessed, executed and enforced from a globally distributed peer-to-peer blockchain. Ultimately, this allows participants to enter into agreements without worrying if their contract will be enforced by the law of a foreign national government. The only thing they have to trust is the network and the technology the contract runs on.
As you can see, there is much potential for smart contracts to become a more important part of the way we do business and enter into agreements among each other. They have the ability to allow for more international trade and more complex types of agreements while maintaining a low cost of enforcement and a higher level of trust. As the technology matures, it is likely that smart contracts will have an impact on your life within the next 10 years.