Smart Contracts: Neither Smart, Nor A Contract

July 19, 2024

In light of the NFT revolution of the past few years bringing the term blockchain to the forefront of the zeitgeist, smart contracts are getting more attention. At first glance, this can sound exciting for a company – automate more and free up resources.  However, smart contracts have limited utility and often do not protect your company in the way you need.  Bottom line: Smart contracts are neither smart, nor a contract. There are legitimate uses that can help a company, but you need to understand where they can help, and where they just create risk. 

What Are Smart Contracts?  

A smart contract is a set of instructions agreed upon by two or more people that automatically execute an action when certain conditions are met. These agreed upon instructions are programmed into a blockchain for storage and processed when triggered by the instruction logic.  

They work by following ‘if…then’ logic. So, if the condition occurs, then the event or action is triggered. Smart contracts can be programmed to have numerous “if … then” conditions. As such, there can be multiple events within one workflow, each assigned a specific condition. For example, a smart contract can allow for partial payments for milestones. 

Misconceptions About Smart Contracts 

There are a lot of misconceptions about what “blockchain” is and can do.  At a high level, in simple terms, blockchain is a method of information storage where the information is not just stored on one database (called a block), but across numerous databases (where the databases are distributed and decentralized) that each hold the exact same information. The blocks are linked by cryptography with date and time stamps. Due to cryptography and it being a distributed ledger, it is reportedly impossible to go back and alter anything after the fact. This way, clear if … then instructions can be carried out over blockchain in a secure manner. 

How Do Smart Contracts Work? 

Smart contracts leverage the immutable nature of blockchain for secure storage and processing of a set of agreed-upon conditions. Given the secure nature of blockchain from being able to be changed/tampered with, the agreed-upon conditions are intended to happen automatically as security is assumed. 

Issues With Smart Contracts 

While smart contracts do have utility, they do not contain legal language, such as terms or conditions, termination clauses, or dispute resolution processes.  All of these terms require more than an “if … then” simple application.   

First and foremost, not all courts recognize smart contracts as actual contracts. You do not want to be in a position where you thought you had recourse through the courts and do not.  As you will see below, smart contracts are more enablers of known outcomes.  “Traditional” contracts can be negotiated to meet your business needs as one size fits all may not work in a complex operating environment. Smart contracts are a misnomer.  

When considering how to use them in your business, it should be thought of as a smart enabler when choices are binary.  As a provider of goods or services, it may be enticing to think “I just have a customer agree to these “if … then” terms and I can get paid as soon as goods are delivered, or services are made available. However, there is the other side of “if the customer makes a claim of faulty good or inadequate service, then you return the money”. The problem becomes more apparent now as there are times when the goods or services are what you were to deliver, but the “fault” is not due to your actions, but user error, inappropriate storage, etc.   

Some Use Cases for Smart Contracts 

Here are some examples of where smart contracts provide value in an “if … then” world.     

Financial Services: 

  • Automated Payments: Smart contracts facilitate automatic payment processing based on pre-defined conditions. 
  • Trade Finance: Streamlining cross-border transactions by automating document verification, payment processing, and compliance checks. 
  • Insurance: Automated claims processing and fraud detection can expedite claims settlement and reduce administrative costs. 

Supply Chain Management: 

  • Provenance Tracking: Ensure product authenticity and track the lifecycle of goods, from production to delivery, enhancing transparency and preventing counterfeiting. 
  • Supply Chain Financing: Improve cash flow for suppliers by automating invoice payments based on delivery milestones. 
  • Inventory Management: Optimize inventory levels and reduce waste by automating replenishment orders based on real-time data. 

Real Estate: 

  • Property Transactions: Simplify property buying and selling processes by automating title transfers, payment processing, and legal document verification. 
  • Fractional Ownership: Enable investment in high-value assets like real estate by allowing fractional ownership through tokenization. 
  • Rental Agreements: Automate rent collection, deposit management, and property maintenance requests for hassle-free rental experiences. 

Healthcare: 

  • Electronic Health Records (EHRs): Securely store and share patient data with authorized parties while ensuring privacy and compliance. 
  • Clinical Trials: Streamline data collection and verification processes in clinical trials, enhancing accuracy and efficiency. 
  • Insurance Claims: Automate claims processing and validation to reduce administrative overhead and improve customer satisfaction. 

Key Takeaways 

  • Smart Contracts Offer Efficiency and Cost Savings: In circumstances where there is a clear application of a condition triggering an event outcome, they can automate processes, streamline operations, reduce manual labor, and minimize the risk of errors, which can lead to cost savings for businesses. 
  • Smart Contracts Enhance Transparency and Trust: Smart contracts are as reliable as the instructions agreed to by the parties and are processed and stored in blockchain – where the transaction can be clearly tracked and is secure.  
  • There Are Legal Considerations: Smart contracts won’t remove the need for legal contracts in business. Remember – they aren’t a contract, it’s a misnomer. They’re a tool that can increase trust and improve efficiencies when there is a clear trigger and response that does not need any further action for completion.  
  • Collaboration is Key: Implementation of smart contracts requires collaboration between business leaders, legal counsel, and technology experts.  
  • Stay Informed: The field of smart contracts is rapidly evolving (and it’s not quite ready for widespread deployment yet). But we think it’s an interesting tool to keep an eye on for future use. 

Just because something is not right for a “smart contract” does not mean that there is not efficiency to be gained in your contracts. If you want to improve your business contracts (including consultation on if a smart contract is right for a situation), reach out. Our corporate attorneys would love to help.  

Disclaimer

The materials available at this website are for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney to obtain advice with respect to any particular issue or problem. Use of and access to this website or any of the e-mail links contained within the site do not create an attorney-client relationship between CGL and the user or browser. The opinions expressed at or through this site are the opinions of the individual author and may not reflect the opinions of the firm or any individual attorney.

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