One of the most promising applications of blockchain technology is the smart contract. It can execute commercial transactions and agreements automatically. It also enforces the obligations of all parties in a contract – without the added expense of a middleman.
Smart contracts (which are one of the most highly anticipated applications of the blockchain ) are computer programs that facilitate, verify, or enforce the negotiation or execution of an agreement. Smart contracts often emulate the logic of regular contractual clauses. Therefore, many kinds of contractual clauses can be made partially or fully self-executing, self-enforcing, or both.
Benefits and conditions
The benefits are obvious: the blockchain is a secure technology, so smart contracts can be more secure than traditional contract law. Also, they can reduce a number of transaction costs associated with contracting, since the blockchain cuts out any middlemen. However, the fact remains that the quality of the output depends on the quality of the input. Smart contracts are by no means magical constructs that understand user intent and are always flawless. If there is an oversight in the text, the result might be even more dramatic than in a traditional contract, because the rules of the smart contract are recorded in computer code and cannot be freely interpreted according to ‘the intent of the contract’, but only according to literal meaning.
The Decentralized Autonomous Organization (DAO) case
The consequences are illustrated by what happened to the DAO, a decentralized autonomous organization for venture capital funding. This organization without employees, existing entirely as computer code on the Ethereum blockchain, was launched with US$ 150 million in crowdfunding in May 2016. Only three weeks later, it was hacked and drained of approximately US$ 50 million in cryptocurrency. The hacker, who was one of the investors, had discovered an unintended loophole in the code of the contract and was able to take the money out. This was technically not an illegal action or a hack in the normal sense – the literal (but flawed) code of the contract actually allowed for this to happen.
As this example shows, smart contracts have not yet reached the appropriate level of maturity we expect of complex legal contracts. Of course, of all the traditional contracts written on paper over the centuries, many were not flawless, either. In fact, many of them still intentionally or unintentionally offer an escape from the conditions to one or both contract parties.
Careful and unambiguous wording is very hard to achieve, and remains so, whether contracts are written on paper or recorded on the blockchain. But if the scope of the smart contract is small enough, with limited complexity, overseeing the consequences and testing for correctness are much easier. This is why experiments with smart contracts are already underway in various industries.
Life term insurance
For instance, Deloitte recently developed a proof of concept for a life term insurance product recorded in a smart contract. Insurance is a logical fit for self-executing smart contracts, since the conditions that lead to a payout can often be clearly defined beforehand in the insurance policy.
Cargo shipping and real estate
Other interesting applications are in development for cargo shipping and real estate. Shipping cargo involves a number of intermediaries that handle papers and payments. Being able to cut out these middlemen and reduce administrative burden may save only a few euros per container, but with hundreds of millions of containers a year, the net savings are tremendous. In real estate, smart contracts can be used to keep an overview of all leases and continuously monitor and verify the payments being received. This greatly improves the process of auditing the leases.
So even though maturity of the technology is still an issue, smart contracts are definitely finding their place – and they are here to stay.