With the emergence of Web 3.0 and blockchain, the questions concerning smart contracts and the ambiguity of their legal binding, is becoming an ever important topic. Here, we will cover all you need to know:

What are smart contracts?

Smart contracts are essentially small batches of code, which are stored on a blockchain and are only executed when specific conditions are met. One way that they differ from traditional contracts is that they are created by programmers and not lawyers. The main idea is that, being a part of a blockchain that doesn’t have a single owner, they too are decentralized, democratized and made more direct. An example of this is any third-party action that would normally be manual such as authorizing transactions, the exchanging or receiving of money or other kinds of services. All of this is now written into the smart contract, eliminating any middleman from the equation.

As an example of this we can compare the common crowdfunding online method to that, made with a smart contract: normally, a person seeking funding can post it on a special platform, but those who wish to invest in it have the uncertainty of whether or not their money will be used accordingly. A smart contract can be programmed in a way where people’s funds are held in it and are only released when the pre-set goal of the project is fulfilled. Another example are the familiar vending machines, which automatically dispense an item after they recognize a transaction. This is a contingent execution process, where one action triggers another, but only after certain conditions have been met.

This new type of blockchain contracts are self-executing through the code they have been written in, and any transaction is forwarded only after the pre-determined criteria of their programming is fulfilled. The data cannot be modified by either party, which adds a layer of transparency and security.

What are the benefits of smart contracts?

Since they are part of a blockchain which has no one single owner, they are safer from potential malicious temperament and, by that token, more direct. Because they are completely automated, the intermediary is eliminated and fulfilment of contractual obligations is more straightforward. This also improves productivity and contractual obligations can be executed within minutes. They also provide the infrastructure for developers to build custom transaction applications both easily and cheaply.

Smart contracts are also self-enforcing. By their mechanical nature, they are precise and have no biases, nor can they be bribed. They can also help lawyers cut-down on the tedious litigation process and the documentation that comes along with it.

They also make for secure and transparent transactions, since the code they are written in is both trackable and irreversible. The encryption they stand behind enhances the parties privacy and protects sensitive data, which, along with being able to share the most recent version of the agreement, can increase both trust and accuracy.

Are smart contracts legally binding?

The short answer is: it depends. Because blockchain and smart contracts are emerging technologies, a lot of governing or legal institutions around the globe are yet to grasp, let alone implement them into their systems. A few states in the USA, as well as institutions in the EU have imposed regulations, but the ambiguity continues in most other parts of the world.

While smart contracts could be enforced like normal ones in state courts, there will likely not be a need for enforcement, since they execute automatically. They do, however, still have to meet the basic legal requirements of a contract, one of them being the mutual consent to be binded by a legal agreement. In other words, they must be based on the terms of a natural language contract, which a programmer needs to be able to translate into exact actions that equate to it. Most smart contracts are expressed only in code, but some also include a version in a natural language. Others yet are written out normally, but also include an encoded payment or other mechanism.

It is also important to note that jurisdiction varies from country to country, and as smart contracts are digital and cross those borders more easily, this is something to potentially look into. This is why a clear jurisdictional clause should be included in the smart contract, so there is a clear understanding as to who is bound by it. This may not include the blockchain platform it inhabits, nor the coder who wrote the contract. Details such as these should be preferably written in a natural language, which can be part of the code or a document outside of it. While they may or may not be legally binding by state law, which varies, they are legally binding in the structure of the blockchain they are situated in. One way of looking at it is the blockchain as a type of sovereign.

A helpful guideline is that you cannot bind people into a contract, whose terms are illegal to enforce. Since smart contracts are generally immutable or difficult to alter, these terms may not be easily severable from the rest of the corpus. This presents a difficulty that normal paper contracts can navigate easier. Some legal agreements like wills, estate and other kinds of documents can’t be signed with an electronic signature. Even though smart contracts involve more transactional operations and will rarely be entwined in these legal situations, it is still worth noting.

What are the obstacles for legally binding smart contracts?

An obstacle for the implementation of legally binding smart contracts, especially for smaller businesses is that it can be a complex endeavour. A lot of enterprises do not have the time, money and most importantly the skilled team to actually write out the codes of these contracts and deploy them to their clients. They also need an understanding of Web 3.0 and its principles. And since it's a relatively new and emerging technology, most business owners simply lack the time to get immersed into it and understand it.

Where can smart contracts be used?

Smart contracts and enterprise blockchain have an emerging benefit in a potentially wide slice of life:

Small businesses

A business is just a stack of interlocked contracts, held in either a file cabinet or a digital folder. They contain all kinds of data, from employment agreements to invoices and all the other minutiae that make the company run. Small enterprises can use smart contracts to bring all this data to the tips of one's fingers, thus saving on a lot of manual searching. All the obligations outlined in a given contract or other document can be automated, added to calendars, and all transactions dispersed when their conditions have been met.

Retailers can also use smart contracts to give all kinds of benefits to their loyal clients. After a certain number of paid transactions, they could receive one for free. Certain services, such as barber shops or street food vendors, have been known to have cards that they stamp out to keep track of this. A smart contract makes this automatic and also a bit more eco-friendly. Another example would be theatres treating their tickets as NFTs, thus eliminating printed ones.

Financial Institutions

Banks and other financial institutions can use smart contracts to automate their entire operations. They can check peoples credit details, allow them loan agreements, oversee the transfer of money automatically, and extract interests directly. This, as well as an increased transactional speed can be some of the beneficial ways of using blockchain in the banking sector.

Healthcare 

Since immediate access to documents in an emergency situation is crucial to save lives, blockchain and smart contracts can help with a substantial increase of medical response. As the information about a patient’s identity is linked directly to the medical data, medical errors are far less likely to happen.

Real estate

 Smart contracts can reduce or eliminate the fees of brokers, transfers or any other intermediaries that require a payment for their services. Much of the record-keeping on a certain property can be stored in the smart contract, which can help save on advisory services and legal counselling.

Music making

The payment of royalties can be made easier and faster through the use of smart contracts. They can include the division of percentages for the artist, label and any other party that might receive money from it.

Are smart contracts the future?

The biggest advantage that smart contracts offer is a clear, optimised directness and transparency. By bypassing the need for costly and drawn-out litigation, businesses can be more efficient and focus on their productivity, while individuals can have an increased security trust in their finances.

If you would like to know more about smart contracts and how this emerging technology can be of great benefit, you can read about 7 Applications of Blockchain Technology in Business.

About INDUSTRIA

INDUSTRIA is a global technology consulting, development, and ventures company with expertise in the field of enterprise blockchain, confidential computing, process automation, and digital experience. As one of the official partners of R3, we are implementing cutting-edge blockchain technologies and reshaping the fintech world. At INDUSTRIA, we are focused on providing permissioned blockchain solutions, such as Central Bank Digital Currencies, Electronic Bill of Lading, and Smart Contracts. Our solutions apply to a wide range of industries and use cases to empower and modernise society.

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