More on Smart Contracts

In a previous article on smart contracts, we explained in detail what smart contracts are, and gave some examples. In today’s article we will focus on some of the challenges, and on recent evolutions that addressed those challenges.

Let us first quickly recap what smart contracts are. Michael Matthews defines a smart contract as “a software program that automates the execution of contract terms. It applies to only the performance of executable terms of a contract. Smart contracts do not replace natural language contracts but instead function as a program that connects to a natural language contract through an addendum that establishes an inviolable link between the program and a natural language contract.” Additionally, while smart contracts are automated contracts, what sets them apart from other automated contracts is the usage of Blockchain technology, which registers the contract and its transactions in distributed ledger.

Traditional contracts have certain disadvantages, which often leads to them being contested in court. They are open to interpretation. They are not machine-readable, and e.g., do not have any meta-data that could provide unambiguous clear data. They are also not self-executable, which quite often would make things more efficient. So, the solution seems simple: create machine readable contracts that can self-execute. The whole process can be automated, and the transactions are trusted and registered. The results is higher efficiency and fewer disputes.

Smart contracts, however, come with their own set of challenges. A first challenge is that imprecise data don’t compute. Typically, smart contracts contain conditions that must be met before certain actions are automatically executed. Those conditions must be sufficiently specific and verifiable for the program to evaluate whether they are met.

A related challenge lies in contradictory language. Just as the data must be specific enough, so must the language that specifies the conditions and actions be unambiguously clear. “When stocks are low”, is not sufficiently clear. But it can’t be defined as “below 20%” on one occasion in the contract, and as “below 15%” on another one.

A third challenge has to do with creating logic parameters. When using a Blockchain ledger, transactions are usually registered in real-time. The problem is that the processing of the data by the parties involved doesn’t always happen in real time. The data could be processed, e.g., once a day, or once an hour… This has to be taken in account, which means parameters have to be determined on how and when to process the data to avoid incongruent data sets, which can’t generate a consensus for a contractual condition.

A fourth challenge consists of anticipating data glitches and gaps. Programs contains bugs, and they also cannot anticipate all conditions that might arise. (A lockdown because of the Coronavirus, e.g., may prevent certain tasks from being executed, even if all previously existing necessary conditions are met).

A fifth challenge had to do with scalability. Processing Blockchain transactions requires considerable computing power, as well as sufficient network speed. More complex transactions require more processing power, and much higher network speed to which only some large entities have access.

An inherent risk with all Blockchain-based technologies is the centralization risk. The strength of Blockchain technology lies in its decentralized ledgers. Tsui S. Ng, in an article for the American Bar Association, rightfully points out that there is a risk “if power is concentrated into a small number of hands. Such concentration means that a group of bad actors may conspire together to approve malicious transactions.”

A last challenge has to do with usability. Just as traditional contracts are written in natural language that machines have difficulties interpreting, smart contracts are primarily written in code and therefore not easily readable by the average lawyer. Tools are needed to bridge the usability gap.

Since we wrote our previous article, nearly two years ago, a lot of progress has been made in addressing these challenges. As a result, the use of smart contracts is constantly and rapidly rising. In his article, Eduard Kotysh points out that the technology is maturing, that new and improved tools are becoming available, and that because the problems are systematically being addressed, trust is building. He concludes that “the ecosystem has gathered enough momentum with the media and events worldwide to hit a critical mass to go viral.” Another important evolution is that the technology has become more accessible.

These evolutions are largely due to the creation of several consortia that collaborate on establishing international platforms, protocols and frameworks for smart contracts and Blockchain backed transactions. Once such platform, e.g., is OpenLaw (www.openlaw.io) which started as a joint US and Swiss open source project that allows lawyers to make legally binding and self-executing agreements on the Ethereum blockchain.

Ethereum is one of the leading platforms for smart contracts and was specifically designed for that purpose. Tsui S. Ng: “Although traditional cryptocurrencies, such as Bitcoin, can store and transfer value, Ethereum is also capable of carrying data in the form of arguments, which means that the platform can be programmed to take a specific action once certain conditions are met. Thus, contracts can be programmed to be self-executing because the platform can send money once the specified conditions are satisfied. Theoretically, given enough time, the platform will eventually be able to solve any computable problem. However, in practice, how well the platform runs depends upon network speed and memory.”

Smart contracts have become so popular, that they even have their own programming languages, of which Solidity is most popular. Another sign of how much the technology has matured is that platforms are being created, such as Solidified, that focus on auditing smart contracts.

In summary, smart contracts are changing how legal matters and contracts are drafted. Michael Matthews points out that this inherently implies that we are finding new ways of working: instead of focusing on risk and liability, like traditional contracts do, with smart contracts we focus on the outcome parties desire. He predicts that in the future, smart contracts will force a new methodology, that of outcome-based thinking.

Sources:

Lamiroy Consulting Blog

More on Smart Contracts

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