Are we about to face a technological refresh of contractual relationships?

The term smart contract can be interpreted as the digital regulation of relationships between parties and the automatic enforcement of rights and obligations arising from these relationships. It seems that smart contracts have a bright future ahead, as the use of smart contracts will allow us to accelerate and automatize several relationships between different entities, which will reduce the costs of transactions and bring trust to the market. However, a number of commercial, technical and legal questions remain to be answered in order to achieve the mass adoption of smart contracts.

The term smart contract was first defined by cryptographer Nick Szabo in his two articles from 1994 and 1997, where he defined it as a computer protocol for transactions which enforces contractual provisions. The advantage of smart contracts should arise from the fact that its violation is more expensive than its enforcement. As an example of smart contract, Nick Szabo mentioned vending machine, which by means of hardware and software enforces a sales contract. Smart contracts were not used at a large scale before the blockchain technology era, as without the technology that would ensure trust in a simple manner, their utilitarian function was quite small. However, now, when smart contracts can be enforced by using the blockchain technology, which ensures trust, smart contracts have gained a significantly greater utilitarian function. Smart contract is thus not a contract, as wrongly indicated by the term, but represents a computer code.

It will be difficult for smart contracts to gain larger significance for the stage of conclusion of a legal agreement, as they face several problems in meeting all the conditions necessary for the validity of a legal agreement. In particular, problems may arise in relation to the declaration of will and reaching of agreement. A smart contract is represented by a computer code, hence contracting parties have to understand it if they want to achieve the concurrence of wills based solely on it. On the other hand, smart contracts will be able to play a greater role at the stage of performance of a legal agreement, where by using smart contracts the parties will be able to automatize the enforcement of rights and obligations from mutual relations. The contractual relationship between the parties will arise outside the smart contract. Only those rights and obligations from the contract, which can be enforced automatically in the digital world, will be transferred into the smart contract. Thereby, the parties will have trust in the correct enforcement because of the trust in the technology and not in the opposing party. The fact that a smart contract follows strictly a computer code and cannot be changed subsequently represents also a limitation. It is usual that the rights and obligations from contracts change due to different reasons. A smart contract can follow these changes only if these changes are provided for in the computer code. In the case of classic contracts, the legal order ensures through different institutions (e.g. rebus sic stantibus, partial failure to perform …) and mechanisms (e.g. filing a lawsuit, judicial enforcement, mutual termination …) that the rights and obligations arising out of a legal transaction are enforced in an appropriate manner. However, a smart contract does not follow all these institutions and mechanisms, but follows only the computer code. For this reason, it seems that in the beginning, smart contracts will serve the automatization of simple exercise behaviour at the stage of performance. Meanwhile, with classic contract concluded in parallel, the contracting parties will maintain all their rights and obligations, which are protected by the legal order and which cannot be protected with smart contracts. With respect to the above, a combination of the use of smart contracts and classic contracts is definitely recommended in the near future.

It is widely known that trust is the essential cornerstone of legal agreements. The meaning and purpose of concluding contracts is precisely in their performance. Several institutions have been formed in the legal order, which protect the performance or strengthen the obligation, as for instance different kinds of collateral, rules on contractual penalty and earnest money and others. Having trust that the other party will perform the contract is of vital importance at the stage of concluding a contract, as the parties conclude the contract only if they have trust in the actual performance of the opposing party. Many believe that independently of the parties, the blockchain technology ensures precisely trust. The technology ensures trust in several ways, from decentralisation, encryption of data, and immutability of data to the needed consent on the content of data entered in a certain block. The technology thus enables to transfer the trust to computers and decentralised platforms that operate based on the blockchain protocol. With regard to classic contracts, which will have the exercise behaviour transferred into the smart contract, this might mean that the trust in the voluntary performance of the contract by the opposing party will no longer be needed, as the trust in the fulfilment of contract will arise out of technology and not out of the sphere of the opposing party.

However, the transfer of contractual provisions into a computer code is faced with many challenges. The programming language with its building blocks is much more rigid and less appropriate for the regulation of social relationships than the literary language with its linguistic signs. The programming language does not enable the definition of general clauses, which constitute abstract provisions, as the programming language can define only concrete steps. Similarly, the programming language disregards the intention of contracting parties in the case of unclear or disputed provisions. These are all practical limitations that will have to be taken into account in the application of smart contracts.

It is estimated that the mass adoption of blockchain technology and thereby of smart contracts will occur within two to four years. The first examples of applying blockchain technology and smart contracts have already been put into practice. Moreover, platforms for simplified and automatic writing of smart contracts and for alternative dispute resolution in relation to smart contracts are already being developed intensively. Nevertheless, a number of challenges from different fields remain to be solved for the use of smart contracts on a more massive scale and thereby for the technological refresh of contractual relationships. Yet we will definitely face a certain technological refresh of obligational relationships in the future.