Smart Contracts in a Paper World

This is the first of several research articles on contract management produced by our MBA students in our online Contract Management class.  The first of these is by Mike Petrillo, reviewing what smart contracts are and how they can change the contracting landscape…

Smart contracts are defined as programming code that can verify, execute and enforce a set of instructions. This code relies on a predetermined set of input triggers. When the input triggers are met, then the transaction of the smart contract is fully executed (Nissen, Haller Grønbæk, 2017). Smart contracts and blockchain technology are both immutable and decentralized. All users of the blockchain validate the outcome of the smart contract.

Specific niche for Smart Contracts?

A unique area for smart contracts to succeed is in the syndicated loan space. A syndicated loan is when loan financing is offered to a single borrower through the conglomeration of multiple lenders. Every syndicated loan usually has a lead arranger (a bank or underwriter firm) that gathers the borrower’s details together (principally repayment details, credit rating, etc.). The benefit of embedding a smart contract in this process is that the contract can securely keep all details of the loan together and have no slippage of key borrower information. If I am a lead arranger, and I must corral 15 funding partners together to share information, it’s going to be significantly easier to share the confidential details of the borrower in a smart contract (that is verified and true), then via costly e-mails, phone calls, and in-person meetings (APTTUS, 2017).

Another major niche of the smart contracts industry was the creation of the Accord Project. The Accord Project is the first legal smart contracts consortium composed of organizations like Hyperledger and the International Association for Commercial and Contract Management (IACCM). The purpose of this consortium is to develop open source technology and standards for computational contracting. This project will address all the requirements for the legal industry as it moves from an intensive paper-based industry to digital. This project is significant because it is considered the first time that the legal industry has come together to build collective standards on contracting. Smart contracts are driving this change (Aitken, 2017).

Opportunities in Deploying Smart Contracts?

The University of Nicosia states the main properties of smart contracts are that they provide control, cost, security, transparency, and flexibility. With control, the smart contracts offer automated execution after individual terms are met. With cost, the execution of a smart contract will require less human interaction then a traditional contract provides. A smart contract also cuts down on paper use and third-parties. With security, every contract is protected by a private key that can only be decrypted by the receiving address. The smart contracts stay secure between the two parties involved. With transparency, all transactions related to the smart contract can be verified and easily seen on the blockchain ledger. Most importantly, smart contracts are flexible. The flexibility allows smart contracts to succeed in many industries, from financial banking, to Internet of Things. These main properties present many opportunities (University of Nicosia, & Borosa, 2018).

For example, with digital rights management (DRM), smart contracts embedded within digital assets (images, videos) could help protect publishers. The smart contract could monitor the number of times the image is downloaded from the web and based on the number of downloads, the smart contract could execute and notify the publisher and terminate the asset from view. Musical artists could sell directly to their consumers without the need for third-party publishers as royalties for their music would be paid out automatically to the artist based on the smart contract. In corporations, software for end-users could be monitored and digitally restricted based on the smart contract terms. When thinking about bandwidth monitoring, smart contracts could be used to observe if a consumer is always getting the appropriate amount of bandwidth at a high availability rate. The bandwidth provider and the customer could add triggers that ensure that the consumer is getting the bandwidth as agreed and if they are not, it could withhold payment to the provider. In manufacturing, a smart contract can govern whom and how many numbers of times a source file can be accessed. If a manufacturer is selling a product design, they can release that product design to a group of people and every time a product is made, it will pay the designer. On the flip side, to support the consumer, if the product fails to be manufactured or print (for 3D printing), it wouldn’t charge the consumer. With the delivery of goods, smart contracts can monitor if a shipment arrives on time. If the shipment arrives on time, the smart contract can release funds to the transportation company. These are all examples of various opportunities in deploying smart contracts. However, many barriers still do exist (Martinez, 2017).

Barriers in Deploying Smart Contracts?

Significant barriers exist in deploying smart contracts. As the nature of smart contracts is decentralization, it is entirely possible that no central administering authority exists to mediate or decide a dispute between participants in a smart contract. This would force every dispute in a smart contract to seek resolution in the court system. Another issue is that it is possible that no clear defendant exists that legal action could be brought against. If the smart contract somehow fails (technology error, operational defects, defective logic) that led to the smart contract not performing as desired, who would be responsible? The lines of responsibility are murky as it is a technology failure of the contract and not necessarily someone in the contract. Some smart contracts could be entirely anonymous. If a smart contract executes and causes harm to the consumer, who could the consumer pursue legal action against if they can not discover who initiated the smart contract? It’s possible that the court system could never possibly identify the other contracting party. During court proceedings, it may not be easy to provide evidence/existence of the smart contract since it exists in electronic format on a distributed ledger. This could be a protected distributed ledger that is not easily accessible, or you could not pull the information up easily in the court of law. If it was a paper-based contract, the individuals can easily bring the paper to court, as compared to a digital blockchain asset. The legal status of a smart contract has yet to be tested in court as many other paper-based contracts have. Multiple jurisdictions may conflict with each other on how to handle a smart contract since it is too new (R3, & Norton Rose Fulbright, 2018).

Another barrier to smart contracts is that adoption is limited. Very few organizations accept digital currency, and many are not on any sort of blockchain technology. This is a relatively new field. A limited amount of technical talent exists to implement blockchain technologies and most companies see blockchain technology as an ominous far-reaching objective. Even if smart contracts became the new standard, only companies that could afford the software engineers to develop them would use and execute them. With widespread adoption will come security concerns. The security necessary to ensure that smart contracts cannot be hacked, and that the currency used to generate the smart contracts could be protected would be important factors to overcome to reach critical mass. Simply stated, smart contracts have an intriguing future and represent the wave of what is to come. It will be mass adopted in time, however; it is going to rely on organizations coming together to make smart contracting easy (Martinez, 2017).

References

Aitken, R. (2017, August 1). Accord Project’s Consortium Launching First Legal ‘Smart Contracts’ With Hyperledger. Retrieved March 1, 2019, from https://www.iaccm.com/resources/?id=9796&cb=1550939367&

APTTUS. (2017, November 16). Smart Contracts Are Here. Is Your Company Ready To Embrace Them? Retrieved March 1, 2019, from https://www.iaccm.com/resources/?id=9975&cb=1550939002&

Martinez, J. (2017, May 11). Will Smart Contracts Revolutionize How We Do Business? Retrieved March 01, 2019, from https://www.iaccm.com/resources/?id=9698&cb=1550939237&

Nissen, M., & Haller Grønbæk, M. V. (2018, August 31). Blockchain technology and competition law – issues to be considered. Retrieved March 1, 2019, from https://www.iaccm.com/resources/?id=10325&cb=1550939002&

R3, & Norton Rose Fulbright. (2018, May 09). Can smart contracts be legally binding contracts? Retrieved March 01, 2019, from https://www.iaccm.com/resources/?id=10153&cb=1550939575&

University of Nicosia, & Borosa, G. (2018). Smart Contracts: Overview of Algorithmic Decision making. Retrieved March 03, 2019, from https://drive.google.com/drive/folders/1MPPb873xNgi2NZ1wTsbVy7DlzJXWEaCW