Expert Insight

Blockchain and smart contracts 101

There are a number of question marks over blockchain security, dispute resolution and data protection compliancy. Should companies take legal advice before engaging with this technology and what are the legal pitfalls?

Technology has substantially impacted the many of the business functions of different companies across various industries, whether it be payroll systems or company intranets.

The areas which have remained fairly stagnant, however, are the processes of bookkeeping and signing contracts. Blockchain and smart contracts are new technologies which have been introduced to change the ways businesses fulfil these functions, bringing them up to speed with modern technology.

As these technologies are fairly new, many have raised questions about the security of using blockchain and smart contracts within your business, as well as their compliance to data protection regulations. In this article, I answer the top questions about these technologies as well as providing insight into the legal implications of using them.

Are smart contracts legally binding?

English law does not prescribe a form of a contract. Just as oral contracts can be formed there is no reason why a contract by code couldn’t be formed. As with all new technology one has to look at the fundamental legal principles. Importantly, parties signing the contract need to understand what is it that they are agreeing to and what the code will do.

The fact that the contract is in a form of a code does not negate the principles of forming a contract; offer, acceptance, consideration and certainty. What does change, however, is predicting when each principle of forming the contract is met. It remains to be seen how the court will decipher these principles when the contract is in the form of a code.

What could a smart contract do?

There are numerous possible uses for smart contact and their uses are almost endless. The security features and the ability to record all steps in a transaction lends its perfectly to scenarios where ownership is being transferred.

For example, when selling property, the property ownership could be transferred automatically upon receipt of the cleared funds. Smart contracts can be used to show who has created a product so there can be little dispute over its intellectual property ownership.

Smart contracts can even be used for paying out insurance policy claims. For instance, there can be a smart contract for a flood insurance policy, linked to data from the Met Office. When the data feed shows the threshold is met, the policy would automatically pay out claims.

What are the advantages of using smart contracts?

It can be cost-effective. If the code works, it can be replicated for similar transactions.

Secondly the inbuilt security features mean that it is very secure. This is ideal for very large financial transactions where considerable sums may be changing hands.

Thirdly, it is very transparent. All parties will see everything that has happened on a particular transaction. This means for example you can clearly track ownership rights such as for intellectual property.

Limitations of smart contracts

Contracts often have a lot of subjective elements. For example, contracts often use the words ‘reasonable’ or ‘best endeavours’ or ‘good faith.’ This leaves room for flexibility. Sometimes this flexibility is intentional because parties want the contracts to be more relational rather than transactional. The contract is designed to evolve as the parties’ relationship evolves. In that case, smart contracts may not be the best option.

Moreover, smart contracts may not (at least for the foreseeable future) be able to deal with the complexity and the length of some transactions.

A lawyer is still needed!

Usually, it is much emphasised that a smart contract is a contract that self-executes through software code, therefore there is no need for lawyers anymore. While it is true that a smart contract self-executes, the conclusion that it makes lawyers redundant is inaccurate.

Despite the wonders of smart contracts, most transactions will still require a lawyer. The reason for this is that the lawyer will still need to assist in negotiating the legal and commercial terms of a contract, advise the client on the law and then take the negotiated deal and convert it into legally binding principles.

The only real change is that there may be an additional step. It is possible that the lawyers may have to sit with programmers to dictate what the code has to do. It does not mean that a lawyer now suddenly needs to learn how to code but it may just extend the function of a lawyer.

Further there is also a lot of discussion over the simplicity of smart contracts and the view that simple language and process will be used to remove what many see as over complicated legal drafted. However, legal language has evolved through centuries of legal cases each deciding on very specific interpretation of common and legal language.

To dispense with such is likely to only foster more disputes rather than aid in their removal. We would therefore urge careful use of smart contracts where there are significant risks of disputes and ensuring all legal expressions are used accurately.

However, this technology may eventually remove the need for third parties such as notaries to validate the authenticity of a document.

Finally, the technology may replace certain functions of a lawyer or change what we believe to be the current functions of a lawyer.  This does not mean that lawyers will be replaced outright but that the legal landscape may change dramatically.

Conclusion

Overall, the use of smart contracts is an interesting concept and it is easy to see how it can revolutionise the way business is conducted. However, the technology is not yet as developed as needed for smart contracts to become a part of everyday work life, but there is certainly scope for it to reach that stage.

Jacqueline Watts is Senior Associate Solicitor at A City Law Firm

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