What is the Future of Smart Contracts?

how do smart contracts work

We live in a world where everything is getting “smarter” from home thermostats to how data is extracted from documents. This transformation is everywhere so it is reasonable to assume that this change will also impact future contracts. For something to be “smart,” a higher level of automation is needed. This means that data and intelligence must be gathered as part of the process. Stated differently, when data is collected and analyzed in the context of how a process is established, automation can deliver an output that is faster and with greater accuracy. In this context, what might be the future of smart contracts?

What is a Smart Contract?

According to Investopedia, a smart contract is self-executing. The contract terms agreed to between a buyer and seller are written directly into lines of code. Based on this definition, a Smart Contract could be considered more of a software application versus a legal agreement. These are not merely digitally signed documents.

The underlying concept is still that of a legal agreement between two (or more) parties. The agreement has a set of conditions mutually agreed to and an outcome that results once conditions have been completed.

As an example, let’s say you insert $2 into a vending machine and press “B4” to buy a soda. You will have executed a Smart Contract to complete this purchase. The action of dispensing the drink was automatically triggered through programming to release a product to you, the buyer. In this example, your identity was authenticated by proximity to the machine.

The initial concept of a Smart Contract has been around since the late 1990s. It wasn’t until the availability of Blockchain that there could be widescale adoption of Smart Contracts. Blockchain provides the necessary security so an agreement cannot be altered or lost. Given its virtual nature, these types of agreements could be executed anywhere. Each transaction must be authenticated in such a way that mutual agreement can be validated for every condition.

Smart Contracts can play a role in the future of Intelligent Process Automation. Read further in this article, Five Reasons to Invest in Intelligent Process Automation.

This video helps provide more details on how a Smart Contract works:

How a Smart Contract Is Used

Smart contracts can be used in a wide range of fields. These range from legal processes and insurance premiums to financial derivatives and home purchases. Repetitive and more standardized legal transactions are ideal candidates for this type of transaction to gain market momentum. As technology evolves, it seems reasonable that more custom transactions could be managed as a Smart Contract. There will just need to be a way to readily establish as many unique conditions or clauses as needed that are each a part of each agreement. And there will need to be a way to easily add new conditions as needed.

Is a Smart Contract Legally Binding?

This is not an easy question to answer. As is typically the case with early technology innovation – the law is rarely the first thing that changes during a time of transformation. The challenge is with enforcement. Each party will need to accept that their intentions were accurately captured and executed. The law will be “defined” as Smart Contracts are contested and brought to court for interpretation. Here is where a judge will decide whether the components of the agreement were satisfied.

As Forbes explains in the article, Smart Contracts And The Law: What You Need To Know, conditions must exist for a contract to be binding. This would apply to either a Smart contract or a traditional paper-based one:

  1. Was there an Offer, Acceptance, and Consideration? Was an agreement established that explained what was to occur? Did all parties accept those terms? Was there any compensation or value exchanged as part of the transaction? If so, then all the core components of a legally binding transaction occurred.
  2. Were the terms legally permissible? You can’t waive your rights by signing an agreement. And you can only include certain legal terms based on the jurisdiction of where the agreement occurred. This will be an interesting component that will need to be better defined in the future of Smart Contracts. Some agreements may only exist on the Internet. A mutually agreed upon geographical location will need to be defined to then interpret the local laws. Alternatively, new laws could be created for agreements in the virtual world – which may or may not be viable.
  3. Is it Legal to sign electronically? Today, some agreements cannot be signed electronically, such as wills and other estate documents; court orders; product recall notices involving health and safety; and eviction notices. For Smart Contracts to be used in these instances, the law will need to change.

What are the Challenges with a Smart Contract?

Because a Smart Contract is literally written in code and then authenticated via Blockchain technology, it is difficult to make frequent changes to an agreement. Purchase and sales agreements of Real Estate are notorious for having additional comments or contingencies added during the inspection phase or during the finalization of securing necessary borrowed funds. A new process will need to be adopted whereby each of these changes can be added as an addendum to a Smart Contract without impacting the logic of how the conditions are executed. Any change will need to be authenticated and validated by all parties. This could be quite complex to start, so might limit initial early adoption.

Another challenge could be in how disputes are handled. Because of the binary nature of how software applications perform, every condition that is part of a Smart Contract could have an unintended consequence – especially if last-minute changes are applied to an agreement where some conditions have already been executed. The potential for complexity in unraveling such an agreement that has not proceeded forward based on the intent of both parties could be difficult to remedy.

What is the Future of Smart Contracts?

Despite the potential for issues and challenges, the potential exists for the future of Smart Contracts to be one of greater adoption and market acceptance. As is the case with new technologies, initial use cases will likely be simple examples where people can get used to working with such instruments. A greater commitment to reviewing every term and condition very carefully will be needed before clicking “Accept” and signing these contracts.