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Apr 2017

Innovation Popcorn: What is a smart contract?

Written by Molly Thomas (The Legal Forecast)
Category: Innovation

Survive Law and The Legal Forecast have teamed up to provide law students with bite-sized, easy-to-understand explainers on the latest law-tech and legal innovation hot topics.

Smart contracts are computer protocols which can execute or enforce the negotiation or performance of a traditional contract. Smart contracts run on computer code which is expressed in logic statements (generally an “if this then that” statement). 

 

Coded Clauses

A contractual clause reading “On 30 June 2017, X will pay to Y $1 million AUD to Y’s elected bank account” is reduced to the code: “If the date 30 June 2017 occurs, pay $1 million AUD to Y’s bank account.” The transaction is automated and the risk of non-compliance is removed. The computer code automatically executes the payment on the specified date, removing the risk associated with human error on the part of X and saving time and money.

Another use for smart contracts relates to variation clauses. If parties wanted to tie a particular clause to the Consumer Price Index, they could choose to code a clause which updates automatically based on data from the Australian Bureau of Statistics. Smart contracts could also be of use in the conveyancing sector where there are a number of key dates and key transactions as these types of data are easy to reduce to logic statements. 

 

What about me?

Despite the undoubted benefits of a smart contract, most agree there is still a need for human brains to be involved. There are some clauses in contracts that are impossible to automate and other clauses in which parties want to retain discretion. 

For example, if a supplier of goods enters into a smart contract with a retailer, the parties may be happy to code the payment terms and have it self-execute on the date the goods are delivered. However, the retailer would likely request an indemnity to account for the possibility of late delivery or faulty goods. This clause would not be able to be coded, and would need to fall under the “manual” part of the contract. 

There is also the issue of context: while contracts generally don’t cover all eventualities, they are created in the context of broader contract law, and therefore the solutions to various contractual issues can be found in that system. This is also true of the expertise required of a practitioner. A fully automated contract would function well for micro-transactions but the initial negotiation of the terms of a contract would still be reliant on traditional legal services.

 

Blockchain

One last point is that the vast majority of smart contracts are executed using blockchain. Smart contracts can be executed either “above” the blockchain (where the software runs outside the blockchain and then feeds information to the blockchain) or “on” the blockchain (where the software is coded into blocks and runs inside the blockchain). This could be a problem because blockchain is non-reversible and may not allow for cases of financial crisis or force majeure. There are also fears about security and privacy. 

Overall, smart contract technology is promising, but will still require the supervision and expertise of professionals in order to function fully. So your job is safe (for now).

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