Smart contracts vs traditional contracts: The right way for business

Brief view on traditional contracts

A traditional contract is a legally binding agreement written in human language between two or more parties. We’ve seen these paper-based contracts everywhere in daily life, from renting a house to acquiring a business. Nowadays, with the help of the internet and e-signature, we also have e-contracts that can be printed out and signed from everywhere.  

For a traditional contract to work, here’re their properties: 

• Offer and Acceptance: One party must make an offer that is accepted by the other. The offer must be straightforward and unequivocal, and acceptance must be unconditional.  
• Consideration: Both parties must receive value for their agreement to be legally binding. It can be money, products, or services. 
• Intention: For a contract to be valid, both parties must wish to enter into legally binding agreements. This is usually determined by the language used in the agreement and the circumstances under which it was created.  
• The Parties’ Capacity: Each party must be legally capable of entering into a contract. For individuals, you must be of legal age and in good mental and physical health, which is usually classified by your country’s law. For businesses, your company must have a legal representative.   
• Legality: The deal must be lawful, meaning that the contract’s terms must not violate any applicable laws or public policy. 
• Content: Other than basic information about each party, date, the agreements between parties, clauses/ section, the contract must also contain authorized signature, lawful governing seal (such as rubber stamp) and the confirmation of a middlemen. 

Pros and cons of using traditional contracts

Advantages of traditional contracts

Despite all the changes in regulation and law, traditional contracts have been in use for thousands of years. 

• Traditional contracts offer legal protection and are court enforceable.  
• Traditional contracts are highly adaptable and can be adjusted to the unique requirements of the parties concerned.  
• Traditional contracts establish a permanent record of the agreement, which can be valuable in a disagreement.  
• Traditional contracts often require less technical expertise to establish and deploy, making them more easily implemented.

Then, Why does it lag behind?

The first reason why traditional contracts are not favored in this fast-paced economy is the lack of automation. Traditional contracts must be manually enforced, meaning parties must meet in person. Imagine the time it takes to set the date and the travel cost. While e-contracts can remedy this by automating the drafting and signing, settling the dispute remains primitive. 

Second, traditional contracts are subject to fraud and misinterpretation. Despite having both parties agree on the terms, they are still documented words, leaving holes for miscommunication. They rely on the confidence and trust between parties, which can easily be affected and lead to disagreements, especially with long-term agreements. 

The rise of smart contracts

Smart contracts promise to minimize the downside of traditional peers by focusing on scalability, centralization, and high security. This new technology introduces a modern approach to legal processing, showered in automation and blockchain as a foundation.  

Unlike a regular contract, which requires manual intervention to update, review, execute, and so on, a smart contract is a computer program that automatically executes, enforces, or verifies contract terms when specified criteria are satisfied.  

To break down this concept, imagine your friend agrees to give you $50 if you make him a cake. You want to make sure that he will pay you after all the effort, so you create a smart contract. The smart contract acts like a middleman that keeps your friend’s money and automatically transfers it to you after the cake is done. If not, the money will be transferred back to your friend. 

Smart contracts have 3 main components:  

• It is written in programming languages such as Solidity (for Ethereum) and Chaincode (for Hyperledger Fabric). This code specifies the terms and conditions of the contract, automates the process based on a defined outline, and ensures that all the data is secured.  
• Smart contracts run on decentralized blockchain networks like Ethereum or Binance Smart Chain. This ensures that no single entity influences the contract, which increases security, transparency, and trustworthiness.  
• Smart contracts are stored on a tamper-proof blockchain ledger after deployment. This immutability guarantees that the contract’s terms cannot be changed or interfered with. 

Offers & concerns of smart contracts

Despite being a new technology, what makes people favor smart contracts?  

• It is more secure than traditional contracts because they are immutable and exist across a distributed, decentralized network.  
• It reduces the risk of fraud and miscommunication because smart contracts automatically enforce agreements after each party has met all the requirements.  
• Decreasing the cost of transactions because they do not require third-party intermediaries or enforcement mechanisms.  
• Smart contracts are transparent and trackable, which improves visibility and trust between parties to the contract.  
• Smart contracts can facilitate complex transactions and agreements that would be difficult or impossible to execute with traditional contracts. 

The downsides of smart contracts to watch out before hand: 

• Smart contracts are not generally adopted, making them challenging to deploy.  
• They aren’t appropriate for all types of transactions and agreements.  
• They limit their usefulness in some scenarios.  
• Smart contracts can’t be fixed once they’re deployed, meaning that if you find security holes or code errors, your best bet is to build a new one. 
• Smart contracts require a certain level of knowledge to build and deploy. You will need legal consultants and specialized blockchain developers to join hands, both of which are in high demand and have a low market supply. 

Comparison of smart contracts vs traditional contracts

Take a look into the differences between traditional contracts vs smart contracts: 

Will smart contracts replace traditional contracts?

It’s hard to say which outweighs the other since each has its perks and controversies. Both serve distinguishing goals.  

Traditional contracts operate in a complicated and ambiguous world, while smart contracts remove the human complex using machines. If the objectives for replacing traditional contracts with smart contracts are cost savings, predictability, and simplicity of use, the latter may be more expensive and potentially less efficient. Furthermore, coding is not immune to error, exploitation, and hacking.   

Many are sure that smart contracts may revolutionize the world and gain widespread usage over time, but they will not replace contract law. They simply provide a technological alternative to the legal system. Yet, the legal system contains dozens of vague terms that can’t be replicated by code.  

Furthermore, given the enormous economic potential of this new way of doing business, regulators may feel obligated to act prematurely with new laws. At most, smart contracts may lessen the need for litigation, but this does not mean that they perform the same purpose more effectively. Instead, transitioning to smart contracts would imply a change in interaction mode. 

Then, What should I choose?

There are several ways to determine whether you need this or that kind of contract, depending on your field of work.  

Traditional contracts are best for sensitive or confidential transactions, sophisticated negotiations requiring human expertise or crucial established legal frameworks.   

Meanwhile, smart contracts are best for trading digital assets such as NFTs, cryptocurrencies, real estate tokenization, and blockchain-based products. They also excel in financial services and supply chain management thanks to provenance tracking ability. 

Can traditional contracts and smart contracts work together?

Yes. You can leverage the best of both worlds and minimize the downside of each. However, we recommend this hybrid method for complex contracts only, as there’s no need to go as far for a simple agreement.  

Here’re the 2 main ways: 

• Integrating smart contracts functionality within traditional contracts 
• Or the more common one: Using smart contracts to automate specific part of agreement execution, while retaining the traditional legal frameworks. For example, Home Depot facilitates smart contracts to manage vendor disputes. The system will automatically transfer the money once the shipment is confirmed and both vendors and Home Depot have the visibility into the tracking.  

Traditional contracts provide a human-readable document for representation. You can share, archive or use it at court. Meanwhile, smart contracts act more like a smart machine, its language is not comprehensible for everybody. Using them in conjunction can enhance your efficiency, transparency and accessibility.

Wrapping up

The differences between smart contracts and traditional contracts have already been implied in their name. While the future of one is unsure, the others will keep on being a fundamental hold of trust and the legal system. But in some cases, combining both can be the way.

More related posts from Blockchain blog you shouldn’t skip:

• Finding the Top 15 Smart Contracts Development Companies
• Top 15 Smart Contract Platforms: Layer-1, Layer-2, Open-source
• Cost & How to Create Smart Contract on Ethereum, Binance & Polygon