Some of you may be aware of smart contracts. They are a new approach to contracting which uses technology to execute and enforce the negotiated terms. In this article we explore what the future of contracting may look like with smart contracts.
What is a Smart Contract?
In essence it is the creation of a contract using computer code rather than the written word. The computer software is then used to enforce and manage the contract, enabling both parties to utilise the contract as a living breathing document.
“’Smart contract’ can refer to any contract which is capable of
executing and/or enforcing itself.”
Smart contracts are written as programming code which defines rules and consequences in the same way that a traditional legal document would, stating the obligations, benefits, and penalties due to either party in various circumstances. However, unlike a traditional contract they also take real-time information as an input, process that information through the rules set out in the contract, and take actions as required.
What are their potential uses?
If we stop and consider the implications of smart contracts - including the ability to electronically execute and enforce a contract in real-time without intervention - their applications could be considerable.
A few examples to get your creative juices flowing:
- Digital Rights Management: limiting what the user may do with the media, prohibiting copying etc.
- Software License Agreements: where the end user is limited in the number of installs of the software in accordance with the number of licenses procured. Historically an issue for both buyer and supplier to manage, requiring the supplier to undertake “spot” audits of the buyer, resulting in the buyer potentially facing unexpected costs.
- Asset Management: enabling the system to automatically pay suppliers for deliveries using the current contracted rate, whilst ensuring compliance with the contractual terms. Ensuring contracted pricing is applied to invoices remains a major area of lost savings for buyers, having smart contracts police this element might be of value.
Smart Contracting is based on Blockchain technology which is used within Bitcoin, an electronic currency system. The technology enables Bitcoin transactions to occur globally in a trusted manner.
To overcome untrusted engagements between two parties today, we have seen the creation of trusted third parties such as PayPal or eBay. These companies facilitate engagement through a middleman, negating the need to create direct relationships. The smart contract model potentially challenges eBay and PayPal by enabling technology to provide the trusted interaction directly.
Is this another “Uber” moment when
existing business models are stood on their head?
By solving the problem of trust and eliminating the need for middlemen, smart contracts could reduce business costs prices and increase flexibility.
Once upon a time, contracts were kept in the drawer and left there until things got ugly. Then technology took contracts out of the drawer and placed them into a centralised system enabling faster access, but little really changed in how they were used. We are now seeing the potential evolution of contract management through the ability to electronically police the terms of contracts
in a pro-active manner. If this can be achieved it could be a fundamental
step change in how contracts are negotiated and managed.
Knowing that each contract could be pro-actively enforced might cause the buyer to reflect which clauses they include, since default contract terms may no longer be suitable. Similarly, suppliers may be more hesitant to commit to terms when they know they will be pro-actively monitored and managed.
It is still early days for smart contracts. Their direction and application within commercial contracting is unclear, but they have the potential to change many aspects of how business is undertaken in the future.
We will continue to watch how smart contracting develops and welcome your feedback. Have you used one?