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Smart contracts: how ‘smart’ are they really?

The term ‘smart contract’ was created in 1996 by computer scientist and lawyer Nick Szabo during his research into digital currency. In a nutshell, they are contracts in which terms are encoded in computer code rather than legal language.

The code defines what happens when particular conditions are met and then automatically performs certain actions when those conditions are fulfilled. A universal example of a smart contract is a vending machine, which contains simple hardcoded rules to enable it to perform certain actions.

In the modern world smart contracts are being created using blockchain. Blockchain is best known as the technology behind digital currency Bitcoin, although its uses extend to a wide range of industries, such as pharmaceuticals and financial services. Essentially, it is a digital network made up of blocks containing records of transactions, chained together through a common set of coded rules. When there is a triggering event, the contract executes itself according to the coded rules.

Combining smart contracts with blockchain can streamline and automate processes and, unlike traditional contracts, eliminate or reduce the need for intermediaries and physical documents. However, there is debate as to whether smart contracts are legally binding and enforceable. This issue goes right to the heart of contract law which states that for a contract to be legally binding there must be, amongst other things, an offer, acceptance and certainty of terms. Some argue that there is no offer and acceptance because the execution of the contract is a unilateral act, and no certainty of terms because smart contracts are too short to include all of the terms between parties.

There is also the fact that in drafting traditional contracts, lawyers can use subtle legal phrases to qualify certain contractual terms. The computer code in smart contracts is made up of hard-and-fast rules and incapable of subjective human intervention.

As for the future, technologically, smart contracts are dependent on the blockchain with which they interact, and this technology is still in its infancy. Legally, smart contract technology will need to be supported by the English legal framework and this will require a substantial review.

Sophie Martyn works in our Legal 500-rated corporate & commercial team. She has general corporate & commercial experience with a particular interest in advising family businesses, LLPs and start-ups. With a background in science, she is naturally analytical in her approach. Email Sophie at [email protected] or call 01242 514000.

Sophie Martyn
Sophie Martyn
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