This article has been written by Hemnaag I pursuing the Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from LawSikho. This article has been edited by Anahita Arya (Senior Associate, Lawsikho), and Ruchika Mohapatra (Associate, Lawsikho).
A contract is a binding agreement between two or more parties and is enforceable by law. Ordinarily, to execute a contract, we reach out to a lawyer and pay them to help expedite the process. What if a contract can self-execute without any help from a third party? Yes, a smart contract is a contract that can be self-executed. The term smart contract was first introduced by “Nick Szabo” in 1997, a computer scientist and a legal scholar who wrote about self-executing contracts or smart contracts. This article will help you gain a detailed overview about smart contracts by exploring the advantages and disadvantages that accompany smart contracts and discussing in detail the inflexibility of execution that comes with it.
A smart contract is a piece of code which can be executed automatically in a deterministic way. Basically, smart contracts are computer programs that act as agreements where the terms of the agreement can be pre-programmed with the ability to self-execute or self-enforce. It operates mechanically, automatically and no human interference is needed. The main goal of a smart contract is to enable two or more anonymous parties to trade and do business with each other without any help from a third party. In simple words, smart contracts are just like traditional contracts. The only difference is that they are completely digital. A smart contract is a computer program with all the terms and conditions of an agreement between the parties. Here, the terms and conditions of an agreement are written in code and when the terms and conditions are met, the contract self-executes. Smart contracts are executed in a blockchain decentralized platform and are written in a programming language called “solidity”. Such contracts are an easier and quicker way to execute an agreement.
How does a smart contract work?
Basically, smart contract works on the “if-then” rules wherein “if” a certain condition is satisfied “then” the smart contract self-executes. First, the contractual parties should determine the terms and conditions for the contract. After the terms and conditions are finalized, they are transferred into programming code. Once the code is created, they are stored in a blockchain network. If the terms of the contract are satisfied and it is verified by all the participants in the blockchain, then the relevant transaction is executed.
“A” and “B” enter into a smart contract to draft a lease agreement for “A”. As we all know, smart contracts operate in computer software code. Here “A” deposits his fee amount for the lease agreement in the smart contract and the amount is on hold until certain conditions are satisfied and “A” uploads all the details along with the terms and conditions as per his requirement. Once the drafting is completed by “B”, he uploads the lease agreement in the smart contract and only after the uploading of the lease agreement, the smart contract is self-executed and “B” gets his compensation and “A” gets his lease agreement.
Advantages of Smart Contract
It is mandatory for a smart contract to have a record of all the terms and conditions in detail. It is one of the basic requirements because any such omission of a transaction may result in future errors. Since smart contracts don’t involve manual filling of forms, it helps us mitigate the margin of human error.
B. Save Time
As smart contracts run on software coding, the transaction speed can be rapid. This could save us a lot more time than it actually takes for drawing up and executing traditional contracts.
It is one of the main features of smart contracts to employ the highest level of data encryption, similar to the one used by cryptocurrencies. Data encryption makes the smart contract more secure on the world wide web. Even Indian banks are trying to adopt this security system in coming times.
The parties involved in the smart contract have full access to all the terms and conditions. No party can change or modify the terms and conditions of the contract without the knowledge of the other parties, creating no chance to dispute once the contract is established. This makes all transactions of a smart contract transparent to all the concerned parties.
E. Paper Free
In today’s business world, everyone is conscious of their impact on the environment. In such a world, smart contracts enable an eco-friendly environment by reducing a lot of paperwork as it is fully based on computer coding.
F. Storage and Backup
In every contract, the details are the key. Smart contracts always record the vital details of each transaction. It also permanently stores the data and is therefore advantageous in cases where the data is missed or lost etc and there is a requirement for retrieving the same
G. Absence of middleman
Unlike traditional contracts, the role of a middleman is less in smart contracts. In other words intermediaries are not needed throughout the contract but at the initial stage.
Example: In a smart contract at the transaction stage there is no need of a middleman, but during the initial stage of a smart contract we need an IT technician for coding works.
H. Meeting of Mind
A smart contract is fully structured by computer codes any changes made by either of the parties gets reflected to the other. Since there is no room for miscommunication or misinterpretation in a smart contract, there is consensus ad idem between the parties.
Disadvantages of Smart Contract
A. Making changes
Making changes in smart contracts is highly difficult in case there arises any error in coding. If there is an amendment to be made to the terms of the contract or the parties have a change of mind and want to change something, immediate changes cannot be made as in a traditional contract. For example, you may change your mind about the rental costs in the apartment, but the data is already registered and it is technically difficult to make corrections. This may bring mistakes into the system and make it a bit cumbersome.
The third-party agents do not disappear but start playing a different role. The need for lawyers experienced in IT increases in the future because the programmers of smart contracts will need consultations for making new kinds of contracts.
C. High cost
The cost incurred in creating a smart contract is very expensive compared to traditional contracts. The costs incurred in the smart contract are coding of the contract, execution of the contract and even auditing of the smart contract etc. Very few professionals are available and it requires a massive knowledge in that field and it is therefore slightly more expensive in comparison with traditional contracts.
6. Why do we need Smart Contracts?
Smart contracts make the work simple. The time period for the process takes only minutes but when it comes to a traditional contract it takes days for the process to get completed. In smart contracts, as the conditions are pre-defined, as soon as the conditions are met the remittance happens automatically.
7. Governing Law
Under the laws of India, smart contracts are legally enforceable and allowed under the Indian Contract Act 1872 and sections 5 and 10 of the Indian Information Technology Act 2000 legally accept digital signatures and find a contract to be legitimate and enforceable by electronic means.
8. Inflexibility of smart contract
The very beginning stage of a smart contract where all the coding work is done itself incurs a huge cost. This stage comprises hiring an IT tech, getting the coding done, etc. But smart contracts leave us with other additional costs too. Money spent on auditing, advertising, etc makes smart contracts more expensive. While discussing how inflexible the costs are in smart contracts, the size of the contract also makes a big difference. A contract in general is larger in size and complex in nature. In a smart contract, to codify an intricate subject, requires a massive knowledge to find bugs or faults and the cost incurred here is naturally high. The smaller and simpler the contract, the higher are the chances for expense negotiation. The costs involved in a smart contract may gradually reduce when its usage is relatively high in the coming future.
Smart contracts provide benefits like saving time, assures accuracy, secured data, clear communication, etc than traditional contracts, despite all the benefits it has few disadvantages too. The smart contract also contributes to this technologically developing world through its fully computerised structure. Though it is fully computerised, we cannot eliminate the need for manual work completely from smart contracts. Smart contracts need to be more transparent because in certain events the law restricts a person to enter into an agreement. So only if the parties are transparent will it be more useful. But there is still hope that smart contracts shall be adopted mostly for small transactions. Once a smart contract becomes easily accessible on trial and error it will be adopted by whomever it requires.
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