SMART CONTRACTS: THE PRESENT, THE FUTURE AND THE LAW
The advent of technology has indeed introduced myriad of changes, even in the most conservative area of law. However, the problem of fast and efficient resolution of breach of contractual terms has always remained. This problem has led to the development of an entirely new area of law known as Alternative Dispute Resolution but this neophyte is not without its own faults. It is only viable for contracts involving a huge amount of money, litigants expend a huge amount of money, the arbitral award may not be enforceable, amongst others. What simple, effective and efficient way is there to enforce contracts and impose binding penalties in case of breach, all within the context of accessibility to everyone? To answer this, we have to turn to the much-hyped cryptocurrencies.
Undoubtedly, cryptocurrencies, irrespective of whether or not they are accepted, are based on sound technology. One such is blockchain, but the one relevant to this discourse is the concept of “smart contract”. The idea was originally described by computer scientist and cryptographer Nick Szabo in 1994. According to Investopedia,
“Smart contracts are self-executing contracts with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network. Smart contracts permit trusted transactions and agreements to be carried out among disparate, anonymous parties without the need for a central authority, legal system, or external enforcement mechanism. They render transactions traceable, transparent, and irreversible.”
How does it work?
Smart contracts make use of existing blockchain technology. As of now, only the Ethereum cryptocurrency has the Ethereum Virtual Machine (EVM) which allows contract codes to be made in any programming language. Basically, a contract (“script” in crypto parlance) is created and stored on a public decentralized network (which means the contract cannot be tampered with) where it remains until any and all conditions precedents are fulfilled. Consequently, to enforce any part of the agreement, all “nodes” (any computer that is hooked up to the computer network) where the contracts are stored must agree that the contract has not been tampered with and that the condition is right for the execution of the contract. However, to prevent abuse, a certain fee known as “gas” must be paid to these nodes to serve as incentives and such is calculated based on how much is needed to get the contract executed.
An example of how smart contracts currently works based on the Ethereum (a cryptocurrency) model can be depicted using a crowdfunding endeavour. First, having identified a project, a smart contract collects money from donors and stores funding in an account with no owner. Funds are kept from founders until they provide proof of progress that satisfies a sufficient proportion of donors, similar to the way public companies are accountable to their shareholders. When milestones are met, funds are released. If founders fail to meet expectations or to bring a product to market, funds are returned to donors. This, therefore, brings a system of security, decentralization, reputation, and accountability that may be expanded and eventually revolutionize centralized applications in every industry.
In theory, many kinds of contractual clauses may be made partially or fully self-executing, self-enforcing, or both, the aim being to provide security that is superior to traditional contract law and to reduce other transaction costs associated with contracting.
However, areas, where smart contracts can be used, include amongst other election, logistics, management, bank system, insurance, estate and Internet of Things.
Challenges and downsides
From every failed experiment, we learn not to do something in a certain way. The Decentralized Autonomous Organization is one of such. The hastily made DAO was a stateless form of investor-directed venture capital fund with an objective to provide a new decentralized business model for organizing both commercial and non-profit enterprises and had no conventional management structure or board of directors. It was instantiated on Ethereum and due to bugs and inherent flaws in the code, it was hacked and about $50 million of Ether at that time was stolen.
From the DAO incidence, certain lessons became clear. First, smart contracts codes cannot be written by just anybody. A professional programmer must be engaged and there must be no bugs or flaws in the codes, a near impossible feat and DAO’s hubris. This is so because a smart contract cannot be revised at will. Also, a party to the contract must be sufficiently grounded enough in programming codes to determine whether the script corresponds to what was agreed on in English as this will determine how the smart contract will behave. Also, the codes must be sufficiently tested to make sure there are no backdoors. All these and the implementation costs make smart contracts as of now a costly endeavour.
In the same vein, contractual terms must be thought through and future circumstances must be factored in. such may include if other parties join the contract, will there be shares split later on, etcetera. Also, the dicey legal nature of smart contracts and the lack of regulations and legal precedent add to the uncertainty. All these and more, fraught smart contracts with pitfalls.
Smart contracts and the law
In trying to make legal contracts into smart contracts, Justice Oliver Wendell Holmes Jr. aphorism that the life of the law has not been logic but experience rings through. This problem has been encapsulated by an observer thus
“The law doesn’t just codify agreements, it carries with it a “spirit of the law”, and we rely on judges, juries and lawyers to interpret the meaning behind the laws we create. Even patent law, which is one of the most formal and codified sectors of the legal system, still contains non-formal concepts such as “obviousness”, and “inventiveness”. A smart contract might be able to track a work-ﬂow through, for example, the application for a patent, but it won’t be able to determine if other patents or scientific papers constitute prior art, or if the application is for an idea that is actually novel.”
While lots of theories as to what course the law will take exists, it is submitted that the common law and equity rules of contractual obligations should apply, but the question still remains as to what the decision will be where the contract is self-enforcing.
Just like fads and fashions, many technological innovations come and go. While some take hold, most end up being cast-offs. The future of smart contracts is still uncertain but it is no doubt that if solutions can be found to some of its pressing challenges, it offers an avenue for cheap, fast and efficient enforcement of contracts. Much, however, hang on government policies and if the recent suppression of cryptocurrencies is anything to go by, it future stands on a precarious balance. Another consideration policymakers will be considering is the close linkage of smart contracts with cryptocurrencies (which are securities according to U.S. Securities and Exchange Commission) and the stateless nature of the later which may indicate that possible parties will be violating securities laws.