The world operates on the basis of a system of contracts. At different levels going from a minor transaction (such as buying a coffee on the way to the office) to a state policy (such as public infrastructure) the way of contracting impacts on people’s lives and, especially, on the way of doing business.
A contract is the agreement of wills between two or more parties, whether they are individuals or legal entities. The applicable legislation establishes the essential requirements that a contract must have to be valid. Although there are some differences among the regulatory requirements, in general, it is agreed that a contract must have:
– Consent of the parties;
– The parties must have legal capacity to contract;
– Lawful object; and
– Consideration.
For certain agreements, the law also requires that they meet a specific formal standard. The form of a contract is the way in which it is recorded, how the terms agreed upon by the parties are captured. The legislations usually agree that certain contracts require formalities that are essential for their validity (for example, real estate contracts usually require written form and many times notarization).
Technology, which is advancing at great speed, has had an impact on the way of doing business and on the way of contracting. However, the rigid regulatory frameworks, risk aversion and traditional legal education have slowed down the speed of implementation of these new developments. The law changes, contracts change, but always a few steps behind technology and business.
Blockchain technology is an example of this difference in speeds that has caused disruptive changes in many industries. There is no need to dive into the valuation of cryptocurrencies. The technological breakthrough that provides us with a public and decentralized record of data has revolutionized the way many businesses envision themselves.
In this context, where the application of blockchain technology continues to expand its boundaries, it is worth asking: What is a smart contract? A smart contract is another way of capturing an agreement of wills. Is it a contract? Yes, it is a contract that is expressed by means of a self-executing computer code based on the compliance of certain conditions, the performance of certain actions by the parties, or the occurrence of certain events.
Contracts represent limits, structures or rules. These limits can be written in many languages and in the form of a computer code that allows them to be self-executing. That is, if certain conditions are met, certain actions materialize. If it is X, it shall be Y.
Let’s look at a basic example: What if, when buying a ticket to travel from place of origin A to destination B, the transport company offers a compensation of 1 Euro per minute of delay to be credited automatically to the account of the passenger who paid for the trip? The travel time from A to B is 60 minutes, the transport was to leave the point of origin at 10 am and arrive at the destination at 11 am. However, due to a delay in the beginning of the trip, the transport arrives at the destination at 11.10 am, so that the passenger automatically receives a deposit of 10 Euros in his account.
If it is X, if the transport is delayed, it shall be Y, the passenger is compensated. This is a simple example that does not explore payment methods, time accounting or external factors that may have generated the delay, but it allows us to see some of the advantages of smart contracts.
The parties agree on the terms and conditions that apply, establishing what events or actions must occur for the agreed consequences to apply. The clauses that establish the terms of the contractual relationship are written in a computer code that, upon receiving information (notification of the arrival time of the transport), executes the provisions (pays the compensation). The code allows the contract to self-execute without the intervention of third parties, and often without the parties even having to do anything.
This way of recording a contract provides some benefits such as: greater speed, lower cost, transparency and certainty (the way of interpretation of what has been agreed is previously established, leaving no room for subjectivities). However, being a new way of writing contracts, we cannot ignore the fact that there are also certain disadvantages related to the high technical complexity and potential security risks. Moreover, the regulatory context, which is still under development, has not yet created a legal framework for its use.
The benefits of this technology are not only evident in the positive impact it provides in certain industries, but it has also given rise to the creation of new business models (decentralized finance, digital art, among others). What is the limit? Possibly the one marked by the functional improvement achieved through this technology and how receptive the market is. It is not a question of using smart contracts just for the sake of using something new. Its use makes sense to the extent that the positive impact is significant and benefits companies or consumers.
The benefits and risks of these contracts are clear for all to see. Their use continues to expand. Industries such as logistics, finance, insurance and real estate are exploring ways to improve the efficiency of their transactions using smart contracts. There are still many features and functionalities to be tested, but every day we will hear more and more about this form of contracting. It may already be more useful to learn to read computer code than to learn a new language.
