This article is written by Anuradha Goel pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from Lawsikho.
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According to Business Insider, the digital media industry in India is expected to grow at 20% to reach a market size of INR 18,938 crore by the end of 2021. The concept of a traditional contract involves three main processes- drafting, negotiation, and implementation of the contract. A traditional contract, if not properly drafted, leaves room for ambiguity and gives rise to disputes between the parties. To minimize the risks and ambiguity, make the transactions faster, accurate, efficient and transparent, smart contracts seem to be a lucrative choice these days.
A smart contract works on a computer code on an if/then principle and executes itself when the required condition is met. A digital asset can be anything that is in an electronic form, for example, a scanned document stored on a computer is a digital asset.
However, executing transactions involving the transfer of digital assets takes a lot of time and resources. The parties want quick, safe, and effective solutions as an alternative to the traditional time-consuming contract mode. In such instances, can smart contracts be the light of the hour? The article aims to explore this possibility.
What is a smart contract?
A smart contract is a contract based on predetermined conditions written in the form of computer code that automatically executes itself. A smart contract does not involve the intervention of a third party and itself identifies the transaction against the terms and executes itself.
The code of a smart contract is stored on a decentralized network such as a blockchain. A blockchain is a collection of encrypted information electronically stored on a network inter-connected and linked through nodes. The code contains the entire set of conditions mutually accepted by the parties and the set of information when the transaction is to be executed. Each transaction is added to the list of information only after verification from a number of people. Therefore, the transactions once executed are irreversible.
A classic example of a smart contract is a vending machine. Upon insertion of money, the machine displays a prompt to insert the code and upon entering the product code, the machine recognizes the transaction and dispenses the product.
Are smart contracts valid?
A number of US states recognize smart contracts. In Australia, Section 8 and 15C of the Electronic Act grants legal recognition to automated electronic contracts.
Section 10 of the Indian Contract Act, 1872 states that “All agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void”
Additionally, Section 5 and Section 10 of the Information Technology Act, 2000 consider digital signatures and e-contracts as valid and enforceable under law. Further, Section 65B of the Indian Evidence Act, 1872 considers digitally signed documents admissible in the court of law.
In India, Bajaj Electricals is already using smart-contract blockchain technology to make payments to its vendors. Additionally, the Reserve Bank of India white paper on blockchain states that the smart contract technology has been deployed on a pilot basis in various projects of the central banks.
Smart contract offers the following advantages over a traditional contract
- It cannot be modified.
- It cannot be blocked/manipulated.
- It has a restrictive human intervention.
- It is safe as the information is encrypted and stored on the system.
- It is cost-efficient as the amount of energy spent on drafting, negotiating, and finalizing the contract through the help of a third party is not involved.
- It works on the If/then principle, leaving no space for ambiguity.
- Since a smart contract runs on software codes, the speed of execution is much faster than the speed of a traditional contract.
What are digital assets?
Digital assets consist of anything that can be stored/saved in an electronic form on a computer. Do you have photographs, files, videos, music on your computer? Do you have an email account? Do you have social media accounts on Facebook, Instagram, Linkedin? Do you have an Amazon, Flipkart, Myntra account to order groceries and clothes? Do you have your own blogs? If the answer to any of the above questions is yes, then my dear friend, you own digital assets.
An interesting point to be noted is that an object initially not classified as a digital asset can become one when converted in an electronic form. For example, a painting when scanned and its photograph is stored on a computer becomes a digital asset. Similarly, a document when scanned and stored on a computer transforms into a digital asset.
Smart contracts and digital assets
Today, all over the world, there are a large number of digital assets that are licensed or sold by people over the internet. Executing these transactions through traditional contract execution channels is time-consuming as there is a lack of trust between the parties. The parties are skeptical about the transparency of the transaction. Issues such as whether the said digital asset shall reach them in an untampered form are also prevalent.
In such instances, smart contracts can lead the way and offer an effective way to address the challenges faced in a traditional mode of contract. Since a smart contract works on a decentralized system of the ledger, it ensures transparency and builds trust among the parties to the transaction.
For example, Wemark is a digital content licensing platform operating through smart contracts. The platform uses its own tokens that users can pay to purchase the content. Although the platform offers transparency, it does not deal with the issue of whether the content has been delivered to the other party.
Proof of delivery is one of the most critical problems in the delivery of digital content. In a research paper written in 2015, it has been suggested that blockchain technology can help to address the issue surrounding the proof of delivery of the digital content to the other party.
The above paper proposes the solution in the following manner
The owner can upload the digital content on a file server where it will be stored. The customer can view and download the digital content from the server by executing a smart contract. For this, the customer needs to pay the money and also provide collateral, kept as a security, that would showcase his honesty and willingness to enter into a contract. The file server shall also provide collateral to the customer. A token, valid only for a limited time period, would be then provided to the customer to download the content. Once the customer downloads the content, the file server shall send a confirmation to the smart contract. The customer then also needs to send his confirmation to settle the payment. Once executed, the collaterals are released and payment is made to the owner. This method shall also resolve the issue of confidentiality as each customer is provided with a unique token number.
An arbitrator is also appointed, who shall decide as to whether the content has been delivered or not in the event of a dispute between the parties. The arbitrator shall download the content using the same token number given to the customer. Based on the download result, a decision shall be arrived at. In case the transaction is not successful, the money is refunded to the customer.
Challenges to smart contracts
Compliance with different laws
One of the principal issues surrounding smart contracts is that the laws of each and every country are different. It becomes difficult to comply with all the laws on a decentralized network. For example, the European citizens under GDPR have the right to be forgotten, which is not possible under blockchain technology-driven smart contracts.
Incorporation of failure conditions
Storing the digital content on the blockchain is expensive. Hence, trusted third parties are equipped and provided with the data content that provides the same to the customer upon request. The smart contract should cover situations wherein erroneous data is provided by a third party or is unable to retrieve the necessary information.
Inability to modify
A smart contract once deployed, cannot be modified. Hence, if a faulty code is deployed or parties mutually agree to change and amend the terms of the contract, it cannot be rectified or amended. A new code needs to be developed and deployed for the said purpose.
Smart contracts have suffered from security vulnerability and breaches in the past leading to huge financial losses. Hence, it is required to verify and test the smart contracts before deployment. It is necessary to test the code for all possible input situations and confirm that it meets the expectations and requirements. It is imperative to test the code for bugs and vulnerabilities to avoid security breaches.
Smart contracts are being adapted as they are less time-consuming than traditional contracts. However, with the increase in traffic, the time taken to execute these contracts is getting extended. Hence, efforts are required to minimize the time required for the execution of these contracts without increasing the cost and compromising the transparency of the system.
Lack of privacy
For few parties, the privacy of the transaction entered into is of utmost importance. Smart contracts are visible and readable by everyone on the blockchain. No read restrictions can be put up by the parties. Hence, this might deter the adoption of smart contracts amongst people.
In conclusion, smart contracts offer transparency and create trust between two untrustworthy parties to a transaction, thereby giving a boost to businesses.
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