THE TECH SERIES

Smart Contracts & Blockchain

When one thinks about something that is “smart” we imagine someone or perhaps even something that is quick witted, intelligent and has all the answers. 

Pondering this thought, we turned to popular culture and stumbled on this quote by Roy H. Williams â€“ 

A smart man makes a mistake, learns from it, and never makes that mistake again. But a wise man finds a smart man and learns from him how to avoid the mistake altogether.

And that kind of makes sense to us. Especially considering this week’s topic – smart contracts (and blockchain). 

Smart contracts, in a way, shows all of us how to avoid mistakes and how to capitalise on ingenuity especially with regards to security and automating our contract processes. 

The point of innovative technology, as always, is to help us do what we need to do, more efficiently, offering better security and often at a reduced cost. 

We therefore hope that this article on smart contracts and blockchain will shed light on what it is, how it works and how it can benefit your practice. 

And whilst legal tech is not quite at the point of “smart contracts”, we do believe this is where it is headed. Therefore, without further ado –

SMART CONTRACTS

As you will see from the below, smart contracts aren’t just contracts stored on a blockchain — they are self-executing pieces of computer code that can facilitate, verify, and enforce the performance of an agreement.

According to Simplilearn, smart contracts are defined as –

“computer programs or protocols for automated transactions that are stored on a blockchain and run-in response to meeting certain conditions. In other words, smart contracts automate the execution of agreements so that all participants can ascertain the outcome as soon as possible without the involvement of an intermediary or time delay.

Munich Re has noted smart contracts as a trend to watch, citing it as a â€œkey feature of modern decentralized ledger technologies”, especially where reinsurance and insurance markets are concerned. This leading reinsurer has done an excellent job of simplifying what a smart contract is –  

“We are all familiar with contracts written in natural language. Smart contracts, on the other hand, are written in programming language and enforce agreements via software rather than law.”

One of the key features of smart contracts and blockchain, as highlighted by Munich Re, is the –

“Automatic execution of agreements via smart contracts offers various advantages in terms of the safety, speed, accuracy, and autonomy of processes. Smart contracts further obviate data loss or manipulation.”

HOW DO SMART CONTRACTS WORK?

Based on IBM’s explanation – 

Smart contracts are agreements that have been codified inside a blockchain. Smart contracts are essentially “code” following the simple â€œif-then” and â€œif-then-else” statements. They’re created with code that is built inside a blockchain. 

Smart contracts have an internal memory containing their code. The code gets executed when predetermined restrictions are met. These restrictions could be internal or external to the smart contract.

If the code for the smart contract needs an external source to determine if it has met its restrictions, it will use an oracle (a source of knowledge). An oracle could be a data feed for weather, for example. This would be useful if the smart contract were executing an insurance contract for crops. 

Smart contract can be programmed by a developer – although, organisations that use blockchain for business provide templates, web interfaces, and other online tools to simplify structuring smart contracts.

WAIT A SECOND, WHAT IS BLOCKCHAIN?

A blockchain is a distributed database that is shared digitally, making it – essentially – a ledger or a record of transactions that cannot be changed, deleted, or destroyed. 

Huh? It can get a little confusing – so we turned to a kind of â€œcheat sheet” on what blockchain actually is – 

“A blockchain is a special kind of database. The term blockchain refers to a whole network of distributed ledger technologies”. 

Note: according to Oxford References, a ledger is â€œa collection of accounts of a similar type. Traditionally, a ledger was a large book with separate pages for each account; in modern systems they will usually consist of computer records”.

“Now imagine a whole suite of incorruptible digital ledgers of economic transactions that can be programmed to record and track not only financial transactions but also virtually everything of value. The blockchain can track things like medical records, land titles, and even voting. It’s a shared, distributed, and unchangeable ledger that records the history of transactions starting with transaction number one. It establishes trust, accountability, and transparency”.

Therefore (and simply put), a blockchain is a database comprised of an innumerable number of similar accounts that are stored digitally (and therefore easily tracked) BUT which cannot be amended or destroyed. Not a piece of paper in sight!

And for legal departments that are struggling under the burden of excessive paperwork and records, the integration of blockchain technology to store information in a transparent and precise fixed ledger rather than a centralised database is a game changer. 

What are the benefits of smart contracts?

According to Getsmarter, Simplilearn and IBM, the benefits of smart contracts can really be summarised as follows – 

1.     Accuracy and speed â€“ once a programmed and recorded condition is met, the contract is executed almost instantaneously. And because smart contracts are digital and automated, there’s no paperwork to process and no time spent correcting errors that often result from manually filling in documents i.e. human error.

2.     Security â€“ blockchain (as we mentioned above) is encrypted, making it an extremely robust system that is difficult to hack. In addition, because each entry on a distributed ledger is linked to the entries before and after it, hackers would have to change the entire chain to change a single record. And that is often far too much of a commitment for the “average” hacker.

3.     Reduced costs â€“ because smart contracts are efficient, they in turn, reduce an organisation’s overall costs. How? Because they create efficiency in processing transactions. This resulting responsiveness reduces manual tasks, including collecting and amending data, as well as the all-important reporting and auditing process. What’s more, smart contracts eliminate the need or involvement of third parties, resulting in fewer time delays (and the fees that come with third parties).

4.     Greater trust and transparency â€“ as blockchain uses a distributed ledger, transactions and data are recorded in multiple locations. Everyone with access to the ledger can view the same information simultaneously, providing full transparency (thereby also eliminating fraud). There’s no need to worry about information being tampered with as there’s no third-party engagement.

Are there any limitations or risks?

Unfortunately, despite the increased security that smart contracts and blockchain offer, there are still some risks that are associated with distributed databases that are shared digitally. According to Munich Re, these include – 

1.     â€œEx-post correction of errors in smart contracts can be difficult or even impossible. The flawless formulation of smart contracts is critical. Unclear or unintended implications may arise if conditions stated in the smart contract are incomplete or ambiguous.

2.     In addition to cyberattacks, third-party exploitation of blockchain protocols and partial lack of security standards are a concern.

3.     Lack of standardization and differences in methodology and coding techniques hinder the interoperability of blockchains.

4.     High legal and regulatory uncertainty remains, as governments are in the process of responding to developments enabled by smart contracts.”

Ø  Side note – do you remember our article on interoperability? For a quick refresher on what interoperability is, click here.

What do we suggest?

As G2 puts it – smart contracts have the potential to completely transform the way we do business. Since they don’t require manual verification by third parties, they are quicker and less expensive than conventional contract drafting. But most importantly, smart contracts are here to stay. 

They are kind of a “no-brainer” – saving users time and money whilst also improving efficiency. Why wouldn’t you use them? Is the question.

We do, however, recommend doing your research. G2 has listed five leading smart contract software based on data they collected in December 2021. So, take a look and discover what will best suit your practice. 

Smart people follow the “smart money”, so perhaps a gander into smart contracts is just what the doctor ordered.

– Written by Alicia Koch on behalf of AJS