WHAT ARE SMART CONTRACTS?
The main disputes about smart contracts in the legal atmosphere are whether they are contracts in the legal sense, or there is a disruptive innovation in the legal system, and benefits, and potential threats. Nevertheless, despite its rapid growth in the literature, legal research on this essential issue is still relatively scarce compared to the effect of smart contracts, which may have in the future.
Definition of Smart Contract
A smart contract is a type of self-executing contract without the need for the parties to take a separate action. One of the traditional instances of a smart contract is a vending machine that dispenses a soda can after the correct currency is entered. However, nowadays, smart contracts are created using blockchain technology and distributed ledger technology.
Nick Szabo is the first person to define the term smart contact. His definition can be popularized to a computer code created to execute contractual tasks automatically upon the occurrence of a triggering event or agreements in which the execution process is usually automated by a computer program. Additionally, The Chamber of Digital Commerce, the world's most crucial trade association representing digital assets and blockchain, has defined smart contracts as "computer code that can automatically specify run-on functions upon the emergence of a certain condition or conditions". As it can be understood, smart contracts are self-executing computer code that is run by a computer, so the presence of artificial intelligence is not a rigid requirement.
In terms of the formation and structure of smart contracts, blockchain technology has a principal place in the scope of digital transformation in the legal field. Blockchain is defined as a distributed database where data between two parties can be easily preserved and permanently recorded, open to the parties, and updated by the participants. The decentralized ecosystem of blockchain does not have any management authority or a single authority looking over the framework. Instead, a group of nodes maintains the network by making it decentralized.
In addition, the existence of an immutable data system is undoubtedly one of the most fundamental features of the blockchain system. An immutable network is one of the best examples of blockchain that keeps its technology as it is. Each node in the system has a copy of the digital ledger. Each node must check its validity to add a transaction. If the majority thinks it is valid, it is added to the ledger. This promotes transparency and makes it corruption-free. Henceforth, no one can add any transaction blocks to the ledger without the permission of most of the nodes. Another fact backing up the list of key blockchain features is that once transaction blocks are added to the ledger, no one can go back and change it. Therefore, no user on the network can edit, delete, or update it.
The Relation Between Smart Contract and Cryptocurrency
There is no doubt that one of the most significant grounds for the real upsurge of smart contracts is the rapid development of blockchain technology. This technology enables smart contracts to use their full potential for automation. Fuelling this technology, Bitcoin has led to the establishment of Ethereum, which is a more sophisticated blockchain platform that allows for more complex transactions (beyond money or Bitcoin transfers). Ethereum has developed its coding system called “Solidity”. Blockchain technology demonstrates how a network can be set up so that once a transaction is triggered, the network can autonomously generate outputs without the direct intervention of any party or any intermediary. Blockchain not only allows every transaction to be verified via nodes (computers on the chain) but contracting within a 'block' and sending it to each node makes execution automatic and in principle immutable - thus enabling 'digitization of trust through certainty of execution' and 'removal of agents'. It allows them to create efficiencies and reduce their cost operations.
Everyday Instances of Smart Contracts
Since the smart contract emerged with Ethereum, it is still broadly used in the banking and financial sectors. However, vice president of blockchain technologies at IBM Jerry Cuomo believes that smart contracts can be used across the entire chain, from financial services to healthcare to insurance. He stated that the areas where smart contracts are used are widening to many diverse industries. Some examples:
1. Health Sector
Most importantly, private health records can be encoded and stored on the blockchain with a private key that will only grant access to specific individuals. This is a reasonable indication that blockchain technology is efficient in preserving patients’ privacy and personal data. On the other hand, surgery receipts can be stored on a blockchain and automatically sent to insurance providers as proof of delivery. Conclusively, the distributed ledger can be used for general health management such as auditing drugs, regulatory compliance, test results, and managing healthcare supplies.
2. Supply Chain Applications
Supply chains are a different business sector that can benefit from smart contracts. Internet of Things (IoT) devices can be used throughout the supply chain to record every step a product undertaken. Smart contract supply chains can eliminate internal theft because managers will be able to pinpoint the exact time and location where a missing product is evident.
Moreover, in huge supply chains like giant warehouses, these smart contracts will allow supervisors to detect real-time stock levels and the time it takes for products to move through the supply chain. Managers can use this data to adjust stock levels, advance delivery times, and develop new work practices. The information contained in these contracts has the potential effect for identifying peak periods of procurement and determining which products to stock at different times of the year.
3. Real Estate
Since the blockchain infrastructure has an uncentralized structure, the ability to trade with smart contracts without the need for third parties eliminates the need for expensive services provided by lawyers and real estate agents. Even though this fact harms the sectors mentioned above, the cost-efficiency of the real estate sectors outweighs the negative impacts on the agents.
The expenses the insurance industry spends on processing claims are undoubtedly high. Not only that, but it also loses millions of dollars to fraudulent claims. In addition to supporting the initial insurance policy, smart contracts can also help improve claims processing in many ways. For instance, they can allow error checks and determine payment amounts based on criteria that consider the type of policy held by the individual or organization. Once again, reduced machining times, a significant reduction in errors, and cheaper costs are among the main benefits.
Furthermore, in the longer term, smart contracts can be used with the Internet of Things (IoT)-enabled tools to allow for pay-as-you-go insurance policies and instant activation of claims after an accident. Information such as driver's licenses, driver records, accident reports, and policy details can be processed immediately to simplify fast payments that benefit both parties.
Advantages and Disadvantages of Smart Contract
There is no need to rely on a broker, lawyer, or other intermediaries to approve as there are parties involved in the deal. This fact also eliminates the danger of manipulation or any attack by a third agent because execution is automatically managed by the network and not by one or possibly biased people.
• No cost
Significantly reduces intermediate costs in the preparation, follow-up, and conclusion of a contract.
Normally, it takes a lot of time and paperwork to process documents manually. Though with the existence of smart contracts; the usage of software code to automate tasks is reducing hours in various business processes.
Documents are encrypted on immutable ledgers, which means transactions are fixed and cannot be altered via other communications.
Despite the many benefits offered by smart contracts, there are technical disadvantages that deter their widespread adoption.
• Incorrect Code
A very essential security concern of using smart contracts is the possibility of bugs in the contract itself that cannot be removed due to the "immutability" of Blockchain technology. Even when codes can be repaired, the process is very overpriced and resource-intensive. In a different context, this vulnerability of smart contracts was highlighted by the infamous DAO hack in 2016. The most reasonable solution would be to use code checks.