SMART CONTRACTS: THE FUTURE OF TRANSACTIONAL PRACTICE
The concept of block chain technology is still new and its utilization at the inception stages. Simply put, a block chain is a database (public or private) that records information in a systematic basis and on a platform that is visible and accessible by users simultaneously. Block chains therefore assist in assuring that transactions or requests introduced onto the networks can be validated in a decentralized system by means of algorithms. Therefore, any transaction or request entered can be assessed or audited by other participants and is not susceptible to unauthorized alterations.
Owing to the decentralized manner in which the block chains can be operated, they hold the potential to irredeemably alter many aspects of transactional practice. There are many examples that already illustrate the potential of block chain. These include crypto currencies such as ethereum and bitcoin. Furthermore, Fintechs are already using block chains to effectuate cross border micro payments and in stock trading. Based on the fact that their use ensures immutable, safe and automated execution of agreements, they are going to completely disrupt contacting for the better.
Block Chains and Smart Contracts
As illustrated above, the qualities of certainty and automated execution make block chains one of the most disruptive technologies yet to be seen. If used in the area of concluding contracts- as smart contracts-intermediaries such as investment advisers, lawyers, architects et al are eliminated from the contracting process because the process becomes peer to peer. Smart contracts are platforms or computer programs that can help facilitate contracting; that is negotiation, reaching consensus and execution of contracts by use of the block chain concept.
Smart contracts utilize the concept of block chains by introducing the necessary algorithms into a network/block chain where the interactions over the algorithms are not limited to a single person or entity. An obligation such as payment for the transfer of an electronic security may be effected from Party A to Party B once Party B meets the requirements of the algorithms that have been set in the block chain to be necessary steps for the transfer of property in the security to A in fulfilment of party B’s obligations to party A. Upon meeting the requirements of the algorithms, there is an automatically legally binding agreement without human intervention, a central depository or an intermediary such as an agent or stock broker.
The Upside of the use of Smart Contracts
Generally, smart contracts engender certainty in that contracts are automatically executed once the conditions required are met and third parties are eliminated in that interactions are purely between the contracting parties. The following are some of the specific benefits that derive from the use of smart contracts:
- Better efficiency in transactions- Immediately upon fulfilment of requisite conditions, the contract is executed automatically
- Reduced transactional costs associated with third parties. Use of third parties such as transactional advisers and intermediaries such as central depositories, stockbrokers and agents generally is eliminated
- Transparency is enhanced due to the visibility of the chain to other members who validate transactions, there is therefore some form of automated internal control
- Risks of contractual breaches is greatly reduced. Obligations ought to be met before the automated execution.
Challenges of the use of Smart Contracts
Despite the foregoing, even at these initial stages of development; certain challenges can be foreseen. These include:
- There is no room for the intervention of regulatory agencies such as the Consumer Protection Agency, the Competition Authority of Kenya and the Capital Markets Authority.
- Despite the decentralized nature of the block chain platform on which smart contracts operate, there is still a risk of hacking. Bit coin has been found to be susceptible to transfer Trojans and Ethereum which mixes the concept of block chains and smart contracts has also been found wanting. Further, DAO, Parity, Coindash and Etherpary have lost millions of dollars to hacking.
Potential future uses of Smart Contracts in Kenya
- Supply Chain Management
In supply chain, once an order is placed, before the actual products reach the person placing the order, there are several intermediaries. The intermediaries in the case of a supply chain include professionals, customs agents, banks and other government officials. These categories of intermediaries act as administrators or validators at different points in the process of the transfer of property. If the smart contract aspect of block chains is utilized, the person placing an order and the recipient can interact on the networks without need for intervention by the intermediaries.
- Land Transactions
Governments including Honduras, Ghana and Georgia are already undertaking projects aimed at administration of land through block chains. The Kenyan government should embrace the use of public block chains in order to automate records involving the ownership, use and transfer of land. This will eliminate corrupt practices that have shrouded land transactions over the years.
- Stock Trading
Smart contracts can also be utilized for purposes of trading in stock exchanges. The nature of the contracts will enable instantaneous execution of contracts upon fulfilment of requisite inbuilt conditions. Since the contracts are negotiated and executed on peer to peer basis and intermediaries such as stock brokers, transactional advisers are excluded, the process of stock trading is made more efficient and cheaper.
- Protection of Intellectual Property
Intellectual property owners have borne the brunt of internet sharing of copyrighted material. Upon loss of control of copyrighted material, there have been immense financial losses in terms of potential earnings. Through smart contracts, the access and purchase of such material can be automated and therefore reduce the possibility of copyright infringement and redistribution. These forms of contracts are already widely used with software licenses.
Smart Contracts can be used in the online purchases of goods and services where the type of contracts is in the form of click wrap contracts. This can be used to facilitate online transactions in which the user must agree to terms and conditions prior to using the product or service.
There is undeniable evidence that smart contracts will alter the conduct of transactional practice. It will greatly enhance efficiency in the manner in which contracts are concluded and executed. Further, if governments fully utilize smart contracts in the conveyance of both real and movable property, corruption will be greatly reduced and transactional turnaround times slashed by more than 50%. Evidently, there is a possibility that entities which do not adopt to the changing times will be overtaken by technology.
Consequently, the law will have to evolve to support and fortify the technology in order to effectuate its uptake. On the other hand, commercial lawyers must keep themselves abreast of these new developments in order to ensure that all possible loopholes including vulnerability or loss that may emanate from an agreement arising out of a smart contract is mitigated. These are factors that will help mitigate the challenges arising from the use of smart contracts.