This article is written by Kashish Khattar, Amity Law School, Delhi [IPU], currently enrolled in the Ace your Internship course at Lawsikho.
The smart contracts were first talked about by Nick Szabo in a research paper that he published back in 1995. They mainly have 3 distinct features:
- They are executed, negotiated and coded in a blockchain technology.
- They are mainly made of yes-no and if-then terms.
- They are authenticated by third party miners who are paid in a cryptocurrency like Etherium.
The concept of smart contracts is a modern and undefined one right now in our country. It can be simply be said as a form of digital contract that is able to implement itself, without the help of any middlemen. Smart contracts along with blockchain technology propose to eliminate the needs of Banks and other third parties which are needed to execute the “consideration” part of the contracts.
Basically, it is a part of the program that stores the rules of negotiations of a contract, checks the contract to automatically verify it and then by the end of it, executes it. It is an easy way of the transaction without any third party being involved in the transaction.
A smart contract is based on a program, unlike a traditional contract which is drafted with the help of human beings. Smart contracts just like the regular contracts define strict rules and consequences of non-performance of the contract. They use certain information as the input, process using the code wrt the regulations. Then move on to take necessary actions that are required to obtain the result.
Smart contracts are legally enforceable as they introduce rights, duties, obligations and remedies to all the parties to the contract and hence are these are legally enforceable as contracts. It fulfils all the conditions of contract law and works efficiently with blockchain technology. Smart contracts cannot be modified easily, the obligations are computer coded. The obligations cannot be modified or amended and the parties will have to code the contract from the scratch.
How do they actually work?
As the terms and conditions have to be encoded in the program, smart contracts are mainly formed around contracts which are based on an ‘if-then situation’ – if x happens then y obligation will be enforced. Smart contracts with these features are best suited for industries like the insurance and the financial services sector.
They are easier to make as there are non-operational clauses involved in these type of contracts. Non-operational clauses are mainly ambiguous and open to various interpretations. Such as good faith obligations and uncertain jurisdiction clauses. They are also self-executory, and hence, self-enforcing kind of contracts. The obligations that are put into the program will be enforced and cannot be stopped midway.
There will be a permanent, time-stamped and irrevocable record of the transaction formed on the blockchain, it is accessible to all the participants in the transaction. The identity of all the parties will remain confidential because all the identification, negotiation and execution is done in code.
Smart Contract over Traditional Contracts
- Smart contracts are easy to understand and comprehend. It ensures authentication and helps in preventing all kinds of frauds.
- In a traditional contract, there will always be a risk factor of the parties not fulfilling their part of the contract. This is not the case in Smart Contracts, as a sanction is needed for the performance of the contract.
- Traditional Contracts can always end up in litigation which can go on for years. Smart contracts ensure that the parties are legally averse to crimes such as cheating and fraud.
- Smart Contracts have a minimal chance of being wrong due to the intervention of computer codes. Traditional contracts are drafted and executed by human beings. The degree of legal exposure will always be greater in traditional contracts.
- Smart Contracts are self-regulated. Traditional contracts can be regulated by a court of law if any kind of dispute arises.
- Smart Contracts nullify the role of banks and third parties, so they are practically cost effective. Complex traditional contracts may involve a team of lawyers which may cost a fortune to the client.
- Traditional contracts, first have to be drafted, then executed and then if the need arises a remedy has to be given by a court of law which can take a lot of time. A smart contract, on the other hand, ensures speedy execution and remedy.
Legality of Smart Contracts around the World
- Firstly, Smart Contracts have to fulfil all the basic essentials of a contract. There must be an offer, acceptance, consideration, lawful subject matter, consideration and parties competent to contract etc. The arguments concerning smart contracts can be of dual layered. First of the evidentiary value of it in courts and whether the digital signature of blockchain technology will be considered valid as an authentication of an electronic agreement.
- In the United States, 47 states in 1999 adopted the Uniform Electronic Transactions Act (“UETA”). The UETA regulates e-contracts, records and signatures etc. It says that the e-contracts are valid and the use of a digital signature will be deemed valid for providing consent. Arizona in 2017, has passed special regulations recognising the blockchain tech. Vermont and Nevada followed by passing laws recognising smart contracts and their execution through blockchain tech.
Regulation of Smart Contracts in India
- The concept of Cryptocurrency was shunned by the Finance Minister in his budget speech this year where he categorically rejected the legal tender of cryptocurrencies. But he in the same speech praised the blockchain technology and issued strong support to the blockchain tech as a whole. Plus, the RBI in it’s circular this year titled withdrew bank supports from virtual currency exchanges.
- Further, there are no rules regulating self-contracts. In a typical fashion with no regulations in sight. They will be regulated by the Indian Contract Act (“ICA”) and the IT Act, 2000 (“IT Act”) and the Indian Evidence Act, 1872.
- A contract to be enforceable in India should fulfil all the basic essentials such as offer, acceptance, consideration, lawful subject matter, consideration and parties competent to contract etc. The blockchain can be programmed in such a way that the payment is mechanised as to the needs of the specific smart contract. The non-performance and non-payment of contract can also be put into check. The smart contracts only work when both the parties have to approve to sanction performance of the contract. The stamping and registration of a contract can also be put into check if the government is also made a party to the contract in the blockchain tech. Think of contracts without any paperwork.
- The IT Act does allow contracts to be validated by the use of electronic signatures. It has placed various regulations on how to obtain a digital signature. Under S35 of the act, it has been specified that the digital signature can only be validated by the government. This does not help the cause of smart contracts where a hash key is used as unique identifier and authenticator produced by the Blockchain technology to validate a smart contract.
- Also, the evidentiary value of smart contracts is put into question under the Evidence Act, 1872 because the specific provisions only make those digital records admissible whose authentication is done by a valid digital signature obtained in consonance with the IT Act.
Commercial Use of Smart Contracts and Blockchain Technology
One of the examples can be, State Bank of India has recently launched BankChain, a platform based on Blockchain made by a consortium of 27 banks, which would proposed to share e-KYC information of all the customers within the consortium. This would save the whole consortium a whole lot of time and effort. Plus, it would ensure there are no leakages in the process.
The government has plans in the pipeline in reforms to the agriculture with blockchain involving quality check, productivity check and nullifying the role of intermediaries in the process of the Agriculture sector.
Smart contracts can revolutionise securities markets, where placing of a purchase order when certain conditions are met, the code can automatically release payments. Syndicated Loans and various banking transactions will get easier with the help of the new age technologies.
Smart contracts can be used in all spheres of lives, from payment gateways to electricity bills, everything will be revolutionised.
Smart contracts and Blockchain can even ease the process of the property transfer agreements. The relevant parties can become the parties to the process, for example – the buyer, the seller, the govt which has to be paid the stamp duty. The process of registration of the documents, notary go all out of the door when the smart contracts come into effect full fledgedly.
Impact on the Legal Industry
The legal sector has to always adapt to the changing needs of the clients. Starting from negotiation to coding the smart contracts, everything can be done by a law firm. The teams just have to update themselves with the basic knowledge of all smart contracts, blockchain technologies and cryptocurrencies. Collaboration with the startup sector and the software firms which deal mainly with these forums is a must.
It would be interesting to see as to how the market evolves with the changing times. The government is expected to come up with some kind of rules and regulations governing the smart contracts and blockchain technology. Smart contracts seem like a fantastic opportunity, especially for the government to stop leakages in various sectors and departments. Smart contracts taking over the traditional contract is bound to happen in the near future. It’s simplicity, low cost are some of the factors that make it a bestseller already.