Can contracts be smart or dumb? Isn’t this just hypallagic nonsense?
According to Wikipedia:
Smart contracts are computer protocols that facilitate, verify, or enforce the negotiation or performance of a contract, or that make a contractual clause unnecessary. Smart contracts usually also have a user interface and often emulate the logic of contractual clauses. Proponents of smart contracts claim that many kinds of contractual clauses may thus be made partially or fully self-executing, self-enforcing, or both. Smart contracts aim to provide security superior to traditional contract law and to reduce other transaction costs associated with contracting.
Wikipedia gives the following examples of smart contracts:
Digital rights management schemes are smart contracts for copyright licenses, as are financial cryptography schemes for financial contracts. Admission control schemes, token bucket algorithms, and other quality of service mechanisms help facilitate network service-level agreements.
In other words, we are dealing with a buzz-phrase whose meaning can vary, depending on the context. If you follow social media, you may have noticed an upsurge in references to smart contracts and blockchain technology (more on which, below) in recent weeks.
Sometimes, the buzz-phrase refers to a method of making contracts. The “smart” part is the use of computers to automate the contracting process. Typically, computers are used to authenticate the parties’ approval of the contract, using encryption technology, or to implement the obligations under the contract, eg by automatically transferring ownership of shares and the payment for those shares.
At other times, the term “smart contract” is misleading (at least in the minds of contract lawyers), and “smart transaction” might be a better (and broader) term. IP Draughts has noticed that many of the articles and comments about this subject seem to be written by computer specialists rather than lawyers, and sometimes the references to contracts are surprising from a lawyer’s perspective. For a good introduction to blockchain technology and its application to transactions, written by commercial lawyers, see this paper by the Australian law firm, Allens.
So far, we could be talking about ideas that have been around for decades. IP Draughts recalls reading articles in computer law journals in the mid-1980s about the use of electronic data interchange, or EDI, as a method of entering into contracts, with digital signatures used to authenticate the transaction. See further, chapter 31 of our book, Execution of Documents (Anderson & Warner, Law Society Publishing, 3rd edition 2015).
In its current manifestation, the idea of smart contracts tends to be linked with the technology of “distributed ledgers”, and in particular those which use blockchain technology. One of the best known uses of blockchain technology is the cryptocurrency known as Bitcoin.
Distributed ledgers provide a new way of storing information on computer networks. The technology is still in its early days, and requires a huge amount of computing power. Potentially, it could revolutionise the way in which information is stored and used electronically. For example, if (in future) your medical records are stored in this way, it should be possible for you to see instantly which doctors have accessed your records, and by withdrawing permission (or breaking the chain) you can instantly remove access to your records. The records would no longer exist in the computer network of the doctors or health service.
In relation to commercial contracts, one of the examples quoted earlier was digital rights management schemes for copyright works. IP Draughts has previously joked on this blog about receiving £0.37 (less commission of 9.75%) from the Authors’ Licensing and Collecting Society for the photocopying of our book, Drafting Confidentiality Agreements by the British Library. If we, the ALCS and the British Library were connected via a blockchain network, and the right set of “contract” terms were established, those royalties could be transferred automatically by the British Library (or even by the person who asked for the copy to be made) into our bank account as soon as the photocopying is done, and without the need for ALCS to check the sums, prepare a statement and send us a payment.
The most obvious applications for smart contracts arise where there is currently a cumbersome, often manual, process that involves several parties. For example, if you as a UK customer make an online payment to a UK supplier, currently it may be necessary to wait for up to 5 days before your bank and the supplier’s bank confirm that the payment has been made. If the payment is made to someone in another country, the delay may be longer. Our firm used an Australian web designer to create the latest manifestation of our website. Paying the designer online seemed to be rather a complex, slow process, and the bank charges were disproportionately large.
Many of the examples that are given of smart contracts are concerned with financial transactions. Generally, the advantages of smart contracts seem more obvious where the transaction is simple to describe but the process for implementing it is currently complex. The benefits are less obvious where the contract is one that has many complex obligations that cannot be simply reduced to a computer code.
Even if the transaction is simple, there remains the issue of whether the parties fully understand it and should be bound by it. Automating the implementation of a contract may remove or reduce opportunities for a party to hold their hand up and say “no, this is not what I meant”. The current litigation in the English High Court between the Libyan Investment Authority and Goldman Sachs is said by some to illustrate this point. See the recent news item by Bloomberg, Blockchain Company’s Smart Contracts Were Dumb.