Quick view on the use of smart contracts
Smart contracts are self-executing contracts or transaction protocols stored on the blockchain system, only running when preconditions are met.
Unlike traditional contracts, smart contracts do not operate based on trust and do not require third-party involvement, thereby helping to minimize arbitration costs and bias. Everything is encoded in the contract, and it will automatically execute what has been set. Because of this, many think smart contracts will replace traditional contracts in the future.
Thanks to the immutable and distributed nature of blockchain, smart contracts have extremely high transparency and security. Everyone can see and search for smart contracts, reducing the chance of contract breach.
Making smart contracts enforceable and legally binding
Smart contracts are a crucial step forward with outstanding benefits compared to traditional contracts. But can you use them in court? Will they be certified proof to resolve disputes? Or are they completely useless and should only be used as an automation tool?
Smart contracts can be legal. But it depends on many factors, especially each country’s specific regulations, hence the controversy over their legality.
In the end, to be able to enforce, they must ensure the basic conditions of an agreement, which are:
Offer, acceptant and consideration
These are the 3 key components of a contract to be considered complete and legally binding by a court of law.
- The offer is given by one or both parties, something that both sides either give up or receive.
- Acceptance is the approval of the proposal by another party.
- The consideration is the exchange of value (monetary or intangible) between two parties specified in the contract.
Before a contract is established, the terms must be clearly defined. This is an extremely difficult task, especially in handshake deals, but much easier in smart contracts.
Why? In smart contracts, all terms are clearly defined and coded to execute automatically. Therefore, they must be accurate and agreed upon by both sides so there is no counterparty risk or time delay in performing each side’s responsibility. To sum up, smart contracts adhere, if not go above, to these minimum requirements.
Legally permissible terms
Traditional contracts, electronic contracts, or smart contracts must not contain unreasonable or illegal terms. However, since you can’t edit smart contracts after execution, you need to make sure such terms are severable from other agreements.
On the other hand, some people might exploit the anonymity and self-execution of smart contracts to cover an illegal action. For example, the use of cryptocurrency for illicit trading in drugs, weapons, pornography, hacks, thefts, and even murder-for-hire. They then hide behind the line of codes without leaving any trace. This is also one of the reasons why many countries are skeptical of cryptocurrency and smart contracts.
Legal for electronic signature
Smart contracts must be legal for electronic signatures. However, here are some types of Legal agreements that do not allowed for electronic signature, including:
- Wills or codicils
- Court notice
- Real estate transfer contract
- Divorce papers
- Birth certificate
- Toxic material transfer documents
- Product recall notices
- Insurance termination notices
- Foreclosure, default, or eviction notices
Smart contracts do not usually involve the above documents, so you don’t have to worry much. For more updates on the latest changes in laws, follow the federal Electronic Signatures in Global and National Commerce (E-SIGN).
If your contract meets all the above requirements and your country supports the use of it, you now have a smart legal contract. It can now be enforced by a court or tribunal, which you can use as a legal document with the same power as a traditional contract. In simpler terms, you can use smart contracts to enforce legal contracts.
Every legal smart contract will contain elements of smart contracts and blockchain technology. But not all smart contracts are smart legal contracts.
How smart contracts are perceived in each country?
As countries worldwide are still exploring the use of blockchain, some have come further by taking steps to regulate and recognize smart contracts in court, while others as still in confusion and skepticism mode.
Countries that passed legislation on the use of smart contracts usually impose clear regulation or framework on how to use it as evidence in legal processing. For examples:
- The US: Arizona, Iowa, Nevada, Wyoming, and Tennessee all provide legal standing of smart contracts, making them enforceable.
- Malta: The first jurisdictions to introduce a regulatory framework to Blockchain (including smart contracts), Fintech and VFA.
- Singapore: Once your smart contracts check out all the binding contract’s requirement, it will be enforceable under Singapore’s Electronic Transactions Act.
On the other hand, there’s no clear report that smart contracts are banned in one country. However, the case is that the government has not yet to impose any regulatory or framework for it to be used in legal setup. And since it’s uncertain, it might not be reliable evidence. For this, you can still use smart contracts as a form of automation.
These countries are China, Russia, India, Nigeria and many more. Despite their widely adoption of blockchain, their support for smart contracts in legality is unclear. However, you can check the Legality of cryptocurrency by country or territory to see how open they are regarding the blockchain world.
Recurring legal issues of smart contracts
Smart contracts offer great benefits that traditional contracts do not have, such as increasing transaction speed, enhancing privacy and transparency, preventing fraud. Smart contracts, however, also come with legal issues.
Negotiation and modification
There are differences between negotiating a traditional contract and a smart contract.
For traditional contracts, the parties may go through many rounds of negotiations to reach final terms. These terms can easily be modified, supplemented, replaced, or removed before or during the contract’s execution. There is always flexibility.
Smart contracts require great accuracy, any small mistake in the contract can result in a big loss. Due to the immutable nature of the blockchain system, changing a record requires a major change throughout the chain. You might have to rewrite the contract and discard the old one.
Dispute resolution
A smart contract is a good alternative to traditional contracts in cases where a traditional contract serves as a mere formality, the transaction with low value compared to the cost of dispute resolution if a breach occurs; dispute resolution processes are complicated, costly, or time-consuming.
Dispute resolution, however, is a big issue of smart contracts.
Smart contracts assure equality and transparency between the parties without the intervention of a third party, thus reducing the risk of fraud related to third parties. Nonetheless, this is also a double-edged sword. When any dispute occurs, it is challenging for a third party to intervene.
Liability
Like dispute resolution, determining liability in case of breach is also a challenge for legal smart contracts. When a breach occurs from either side or loss due to hackers happens, it is difficult to determine who is responsible for the loss.
International trade
Smart contracts can be used in cross-border transactions. Therefore, they need to be guaranteed to comply with legal regulations on international trade.
Even so, because many countries still need clear regulations on smart contracts, there are still many difficulties in complying with both international as well as domestic trade law.
Wrapping up
By understanding how smart contracts and the law work together, you can easily write a legal smart contract. If you need any help, Synodus is here for you! Have a chat with our expert and see how we make your smart contract legally binding, more efficient and consume less gas.
