How Do Blockchain “Smart Contracts” Work?

  • Smart contracts have revolutionized the ways individuals and companies do business with one another.
  • They operate with greater efficiency, transparency, and autonomy than regular contracting and eliminate the excess transaction costs and trust problems associated with including intermediaries in the transaction.
  • However, smart contacts are unchartered territory; there is little and inconsistent regulation. They also lack the leeway for negotiation, judgment, and revision, which some contracts depend upon.
  • Consider hiring an experienced attorney to advise you on complex issues regarding the creation, execution, and monitoring of smart contracts.

Experienced Defense Team

As the world is revolutionized by virtual technological advances as seen with social media and shopping, why should contracting be any different?

Smart contracts enable parties to instantly execute a transaction if a given, pre-determined set of conditions occur. However, as they are a novel form of contracting, they are inconsistently regulated.

If you need legal help or advice regarding the terms, operations, execution, or monitoring of a smart contract, contact our office today. Our attorneys are skilled at advising our clients on complex issues regarding smart contracts.

It is critical that you are given advice and represented by an experienced attorney with extensive knowledge of the operations of smart contracts.

Do not wait to get in touch with a qualified attorney today. Put Oberheiden, P.C. on your side to advise you on these novel legal issues surrounding smart contracts.

What is a Smart Contract?

A smart contract is a self-executing agreement embedded in computer code and stored on a blockchain. The code is composed of a set of rules that the parties to the agreement have agreed to. If and when those predefined conditions of the agreement are met, the terms of the smart contract are automatically enforced.

The transaction is then recorded and stored in a blockchain, which is a transparent, distributed public ledger that is protected from deletion or revision. A smart contract is, in essence, a piece of computer code that is capable of executing an agreement that the people who developed them have created.

Using code to produce a certain effect if a given condition occurs is not a new phenomenon. What is unique about smart contracts, however, is that it takes this coding and unites it with the blockchain to interact with multiple systems at once and produce pre-determined situations.

There are three elements to a smart contract:

  • the parties—two or more—using the smart contract and agreeing to the terms of the contract
  • the subject matter of the agreement that the smart contract has direct access to
  • a set of specific terms that are denoted in programming language for the smart contract

What Does a Smart Contract Do?

The Process Explained

A smart contract operates with simple “if…then” or “when…then” statements. These statements are written into the blockchain and are not activated unless and until the condition occurs. Once the condition occurs, a network of computers executes the actions. The action that occurs is whatever command that is placed in the blockchain to take effect upon the verification of a prior stated event. Such action could include commands such as “release the funds,” “issue a ticket,” or “register the car.” Once this occurs, the blockchain is updated.

But how are these commands created? The parties mutually agree to a set of commands that will be placed in the blockchain. There can be as many commands as the parties need to satisfy the transaction. The parties agree to various conditions including the commands that govern the execution of the smart contract and any exceptions.

Once everything is completed, the transaction is stored on the blockchain, which is not limited to closed systems nor viewable only to a single party but instead placed on a public, transparent ledger.

An Illustration of a Smart Contract in Action

If you buy a car at a dealership, you will be requiring the services of several intermediaries across different departments such as lenders, salespersons, finance agents, etc. If you need a loan to purchase the car, the process for getting approved for financing will require multiple documentation to be filled out along with a credit check, identity verification, and income verification. Paying for the services of these intermediaries is generally added to the price of the car.

Smart contracts eliminate the intermediaries in the transaction. In our above example, the individual’s identity is stored on the blockchain, which allows lenders to easily and swiftly make a decision about financing.

Once the credit decision is reached, the smart contract is executed, and the dealer receives the money, the bank receives the title, and you receive your car with the repayment terms based on the pre-defined details of the smart contract. This process is automatic and gets stored on the shared blockchain.

The same process can be applied to any typical present-day business reality such as buying a house with the services of a real estate agent. The transfer of the property here would be automatic upon receipt of funds.

Additionally, other aspects of the business world could be revolutionized; for instance, securities could be traded without utilizing the services of a central securities depository.

Advantages and Benefits of a Smart Contract

There are several advantages and potential benefits of a smart contract:

  • Autonomy: a smart contract eliminates the middleman, intermediary, or other third-party facilitator, which gives the parties to the agreement complete control
  • Lower transaction costs: because the intermediaries—closing agents, notaries, financial advisors, bankers, etc.– are not needed, the parties save money by not having to pay for these services
  • Eliminates “trust” problems between parties: a smart contract eliminates the need to rely on various individuals in order to complete the transaction and instead automatically executes, encrypts, and then safely stores the documents on a secured ledger
  • Efficiency: smart contracts are self-verifying and self-executing, meaning they can audit a transaction or enforce a command instantaneously without interruption—saving time
  • Transparency: smart contracts operate on transparency and therefore serve to assist in the effective regulation of markets
  • Safety: smart contracts are difficult to hack and protected by complex cryptography
  • Decentralization: smart contracts are decentralized, which reduces the risk of corruption to the files and permanent data loss
  • Business cooperation and collaboration: smart contracts can be enforced in a manner by which all business participants can be assured of its outcome without the need to resort to an intermediary or other third party
  • Serves as an exchange of value: smart contracts can facilitate the exchange of money, property, or anything with value

Risks and Limitations of a Smart Contract

There are similarly several risks and limitations of a smart contract that should be noted:

  • Revisions are not allowed: after execution of the smart contract, there can be no revisions or amendments, which is sometimes necessary in certain cases
  • Lack of regulation: because of the novelty of smart contracts, the government has not fully addressed how smart contracts ought to be regulated, and, by extension, how damages or injury ought to be addressed
  • No room for judgment: while smart contracts can obey standardized commands for repeat transactions, they cannot judge if a condition has been substantially met nor can they judge negotiations
  • Potential for fraud: smart contracts can be infected with bugs or be the product of fraudulent commands
  • Transition and harmonization issues: there may be significant hurdles in convincing existing technological systems to transition onto blockchain technology for smart contracts
  • Price: decentralized systems can sometimes be more costly than a centralized system and require a blockchain with sufficient computational power

Need Advice with a Smart Contract?

Smart contracts can eliminate the time, expense, and hassles associated with regular contracting. While this can be a good thing, it could also present some novel legal challenges.

If you need advice on how to proceed with a complex smart contract issue or are having problems with a smart contract, do not hesitate to contact an experienced defense attorney today.

The attorneys at Oberheiden, P.C. have the experience and knowledge needed to advise you through all the unchartered territory of smart contract regulation and enforcement.

Call or contact our office for a free consultation to help resolve these challenges.

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