Smart contracts are simply digital contracts utilizing a blockchain platform, and are automatically executed fully or partially after specific events occur. For those new to blockchain, the term refers to a shared, secure transactional ledger that eliminates the duplications that can occur in more traditional business processes. A “block” is a single transaction that records the movement of an asset, and additional transactions are “chained” together irreversibly to form the blockchain.
Because transactions are only recorded once and irreversible, any errors must be corrected with an additional transaction. Further, building blocks upon blocks strengthens the chain and verification process by making any attempt at tampering extremely obvious, and thus preventing bad actors from fouling the process. Because of this structure and transactional integrity, blockchain is a trustworthy ledger of transactions that can power smart contracts.
The way that smart contracts work is a simple process of coding “if / when / then” commands into the blockchain. As transactions are recorded, if a set of predetermined ifs / whens / etc. occur and are verified, then certain actions are executed as part of the contract.
For example, if a buyer releases funds to a seller, the blockchain updates with that transaction, which can then trigger another action, such as completion of the contract or notification to release a title, etc. Just like traditional contracts step through a process, smart contracts can include as many levels as needed to work through an agreement. Both parties simply need to agree beforehand on the stipulations and how transactions are represented in the blockchain.
Initially, smart contracts required the assistance of a developer to create, but more and more services are providing templates and tools to make the process more accessible to businesses. This makes them a tempting option when time and efficiency are tantamount to working through an agreement.
Smart contract benefits include speed and efficiency, and improved accuracy, as well as full transparency. Records are shared between parties, eliminating a third party, and are encrypted to prevent malicious alteration. This also makes them more difficult to hack, and hackers would need to tamper with the entire chain to make a single transaction adjustment.
When using smart contracts in cross-border transactions, for example, the complexities of differing laws and regulations between states and nations could complicate the process. If a government or regulatory entity wants to regulate any transactions, a third party would need to step in to ensure compliance.
Smart contract transactions are immutable, making it impossible to undo or adjust an erroneous transaction. While this provides transparency and exposes any attempts at tampering, it also complicates matters if a law or regulation changes, likely necessitating a completely new contract.
Additionally, confidentiality can be an issue. Blockchain relies on its transparency to prevent fraudulent activities, so participants may use coding to hide confidential information. However, that code can be revealed by a simple View Source command, which would display all html coding and thus any hidden confidential information.
Because smart contracts are peer-to-peer agreements, they do not require lawyers to witness or sign them. This leaves both parties open to risk of future litigation.
Finally, despite encryption, smart contracts can still be vulnerable to software bugs and vulnerabilities that can be taken advantage of. Developers are working to improve those vulnerabilities, and while most sources agree that smart contracts are secure, users should proceed with caution.
The experienced attorneys at Hackstaff, Snow, Atkinson & Griess are here to guide you through transactions and agreements in business and elsewhere. We have the breadth of expertise to provide comprehensive legal services from multiple perspectives to find the best solution for you. Contact us today.
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