A smart contract is a computerized transaction protocol that executes the terms of a contract. As so defined by Nick Szabo back in the early 90s, smart contracts have become one of the key technological innovations of the new millennium. No wonder how nowadays they are on everyone’s lips. But do people really know what exactly is a smart contract and how does it work? Let’s find it out.
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You have described smart contracts as a sort of computer program. So why do we keep calling them “contracts”?
That’s exactly the point we need to start from. Let’s say once and for all that smart contracts are neither “smart” nor “contracts”. At least not in the sense in which we are used to knowing these terms.
When we refer to a software or an algorithm as “smart”, we tend to think about artificial intelligence: the simulation of human intelligence in machines that are programmed to think like humans and mimic their actions. Nothing more distant from the basic operative mechanism of a smart contract. Far from having its own intellective faculties, a smart contract simply executes specific pre-determined conditions when certain events occur, according to the so-called “if-then” conditional programming. The encoding operation can be quite complex, due to the versatility of computer programming and the possible intersection of multiple events (“trigger points”) in the code, but it still runs within rigid and predetermined boundaries. Not very smart, right?
Even the mere translation of contractual terms in binary code and their implementation on the blockchain is difficult to include in the legal definition of a contract, intended as an agreement of two or more parties to establish, regulate or terminate an economic relationship between them. On a closer (and boringly legal) look, a smart contract appears much more like an act of performance of a previous contract, rather than a contract itself.
As a result, there is no need for lawyers to worry about being replaced, right?
Exactly. Although several academics – both in the legal and IT field – envisage a scenario in which smart contracts will partially replace contracts, it seems to be a rather unrealistic perspective, especially in the short term. Given the potential complexity of a contractual relationship and the overall multiformity of business interactions, there will always be a demand for much more structured agreements and for someone to write and enforce them. Therefore, lawyers and notaries, who first felt threatened by the advent of the blockchain, should not fear the increasingly widespread use of smart contracts but embrace it instead.
Automatic, self-executing and irreversible, smart contracts promise to simplify many daily operations, especially repetitive and standardized ones. This is already happening without us even noticing it. Financial services and insurance companies already rely on algorithmic programming to speed up any kind of monetary transaction and insurance policy, thus saving both time and money, and they are committed to investing always more in this process.
I understand that blockchain and smart contract are two sides of the same coin. Is it really so?
Well, the blockchain is basically the underline technology that makes all of this possible. Once encoded in binary code (by a programmer, it goes without saying), the smart contract would remain nothing but a piece of encrypted code. Only with its deployment on the chain of blocks and its validation by the nodes participating in it (through a sequence of technical steps as hashing, timestamping, mining and so on) a smart contract comes to life. With the technological advancement of the blockchain, it will be possible to encode increasingly complex and efficient smart contracts. I think about the development of DApps (decentralized applications) interoperable on multiple blockchains, or the exponential growth witnessed in the field of the Internet of Things/Everything (IoT/IoE). If you consider that almost every connected product is supplied by hardware sensors and/or software APIs that could potentially reconnect to smart contracts, their essential role becomes very clear. Not to mention the leap forward expected with the Ethereum shift from a proof-of-work based consensus protocol to a proof-of-stake based one.
Far from being the beginning of the end of contract law, smart contracts will undoubtedly be part of the future of contracting. In which way? We just have to wait and discover it.