Scholars and researchers continue to explore and exploit the capabilities of the internet, giving rise to some of the popular buzzwords today, like cryptocurrency, cryptography, and blockchain. These technologies gave birth to a number of smarter, automated processes, which can be extremely beneficial for e-commerce and other industries. One of the products of these innovations is the smart contract.
What are Smart Contracts?
In 1994, an American computer scientist named Nick Szabo introduced the concept of smart contracts. Smart contracts are self-executing contracts between two parties that are controlled through instructions written in lines of codes. These codes and the agreements of the contract are contained in a decentralized, distributed blockchain network. Although the concept first appeared in the ‘90s, the actual execution didn’t happen until blockchain technology was developed.
A computer programmer converts the terms and conditions of a traditional contract into a computer code and uploads the script into the blockchain. These codes can facilitate, enforce, and execute the commercial agreements between the buyer and the seller. A data scientist can program the codes to perform automatic responses to certain actions and conditions. For example, the contract can automatically terminate itself after the last binding day of the agreement.
Smart contracts also enable machines with virtual wallets to conduct financial transactions with other devices. This eliminates the need for third parties and maintains the business operations within a tight-knit group of individuals.
Potential Risks and Challenges
The use of blockchain technologies and smart contracts poses a risk for deployment, governance, regulatory, and data security. All concerned participants may avoid these risks by observing certain standards to ensure accuracy and trustworthiness.
Because the blockchain is a decentralized system, it may be difficult to change the terms of the contract when need be. All the involved parties must agree and accept the amendments for the contract to function consistently.
Below are some of the other challenges in the practical implementation of smart contracts:
- Mistake, error, or fraud – Because the blockchain network is decentralized, there may be discrepancies in the specifics of the contract. One possible scenario is when the code doesn’t match the natural language description of one party’s obligation. Such a problem necessitates e-discovery solutions so the parties can prove that there were no malicious alterations or corruption of the digital records. A judge will also need to determine which clause prevails by looking at the two contract versions as one and identifying the true intent of the parties.
- Legality – In some cases, a judge doesn’t consider codes as law, so it’s not enough to rely on machine-readable codes to make the contractual terms binding. The judge will need to determine whether these terms are legally binding or not.
- Enforceability – Smart contracts are subject to the same body of law as traditional contracts. But since these documents rely on technology, there may be challenges when it comes to legal enforceability and governance. When a dispute arises, there may be no central administering authority to resolve the issue. The best way to avoid enforceability problems is to establish dispute resolution mechanisms early in the process.
Like most technological innovations, smart contracts have benefits and drawbacks. Businesses must first study the legalities and mechanics of smart contracts before utilizing it. This will ensure that they’re not exposing the name of their company to legal risks.