Contract law has been a fundamental cornerstone of the formation of modern human society. Smart contracts, an expression coined by Nick Szabo, represent a digital evolution of contracts.
Szabo coined the term in 1997 to described self-enforcing digital contracts.
The advent of the blockchain — the distributed ledger employed by Bitcoin — has enabled the concept of smart concepts to come to life.
What is a smart contract?
A smart contract is one that is “capable of executing or enforcing itself,” writes Cryptorials’ Dean Walsh.
“Smart contracts are written as programming code rather which can be run on a computer rather than in legal language on a printed document.”
By definition, it is not necessarily a legal contract: It has programming code to detail strict rules and consequences.Thus it mirrors a normal contract in that such obligations are outlined, as are the breach penalties for non-conformance.
Are they really smart?
Smart contracts are “modular, repeatable and autonomous scripts, usually running on a blockchain, which represent unilateral promises to provide a determinate computation,” states a BBVA paper (PDF).
“These scripts are stored in the blockchain at a particular address, which is determined when the contracts are deployed to the blockchain.”
When the specified event in the contract occurs, a transaction is automatically sent to execute the code. An example I recently heard a startup pitch was a new water market.This platform created a market where buyers used traditional contracts when they bid for quantities of water, which were then paid by bank transfers.
But in the world of a smart contract, the contract would detect who used the water, perhaps signalled from IoT sensor.There would be an automatic audit trail of the quantity, time, date, quality of water was shipped and received, from A to B.An agreed contract payment term would be invoked to make the required financial transaction also settled in real time.
Read more: ASX wants its own blockchain
Where else could you use a smart contract?
A loan could be stored as a smart contracts (in the blockchain) and also with collateral ownership information. In an example where the loan is completed, then the token for digital rights will be transferred. Similarly, if a default occurs and the borrower misses a repayment, then a smart contract could automatically revoke the digital keys that grant his or her access to the collateral.
Therefore if we take the example of a car loan, then your finance company could prevent you from being able to access or start your motor vehicle.
Smart contracts that also be established for securities and this would monitor the performance of digital or non-digital assets (futures, forwards, swaps and options)
The middleman is gone
Smart contracts, by definition, operate where there is no thrust between the parties.They allow individuals to contract with each other and manage the payments of funds without the middleman.
We use eBay and Amazon as intermediaries when we conduct trade over the Internet —we trust that these bodies to ensure that the goods will be legitimate and we also don’t want our credit card details held by shady characters.
In the case of music, it could potentially reduce file sharing.If you purchase songs or video media, a smart contract may you the right to use it.Your right to this would be stored on the blockchain — and it could be a specific digital right; for instance, the right to play it once in the next three months.
Smart contracts don’t mean that we trust the other party – it just means that they mechanism is automated so that you cannot be cheated.
See you in court!
Clearly this is all yet to be tested in court.One major drawback is that smart contracts assume that parties know all the rules at the beginning of their collaboration.Thus smart contracts must have mechanisms to allow parties to amend their agreements as mutually desired.
But given their ‘automatically execute’ nature, smart contracts may hold the potential to significantly reduce the chances of a dispute reaching court.
If you default on your car loan – then you can’t start the car and it automatically returns to the finance company, or is even put up for immediate auction and delivered to the new owner.
In the future, we will all learn to use smart contracts — and they will talk to each other.