Introduction to Smart Contracts:

S M A R T C O N T R A C T S

Do they have to be legally binding?

Smart contracts consist of code instead of paper. The advantage lies in the automatic execution in the event of certain conditions being met. But what exactly makes intelligent contracts and what is their legal status?

Smart Contracts enable automatic contracts that are executed when certain conditions are met.

Smart Contracts are particularly popular in the insurance industry: claims can be settled directly, without third parties and completely automatically. But how do smart contracts work and are they legally binding?

The government of Tennessee has officially recognized Smart Contracts. That’s good news when we talk about the element of the general public. As a result of such events, Blockchain and all related technologies are approaching the state of a standard. However, practice shows that the deeper you get into the different aspects, the more you understand that you are at the beginning of a long and uncertain road. But before considering Smart Contracts based on Tennessee rules, the concept should be explained in a simple way.

Classic Contract vs. Smart Contract

A classic contract is a certified piece of paper that lists what actions should happen if certain conditions apply. Suppose there is a group of individuals who want to make rules about how and under what conditions certain values are assigned. They need guarantees. That is why they set up a contract together. This paper does not control the implementation of the defined actions but safeguards them. If the contract objects are violated, one can go to court — where the problem is solved if enough evidence for illegal behavior can be provided.

A smart contract specifies the conditions in exactly the same way as a paper contract. Since a Smart Contract is program code, it can perform actions — which is impossible if it is only made of paper.

Typically, smart contracts are executed in a decentralized environment in which

  • Anyone can become a validator as well as verify the authenticity of the correct execution and the status of the database. Distributed and independent validators minimize the need for third-party vendors and provide assurance about the immutability of what needs to be done. Therefore, every smart contract should be checked for errors before it is used. Once published, changes are no longer possible.
  • All assets must be digitized. All data that could trigger the execution of the Smart Contract must be stored in a database.

What are oracles?

There is a popular myth that smart contracts on the Ethereum blockchain can pull external data from the web and use it in their environment, for example, that a smart contract transfers money to someone when a football bet is lost. This is not possible because the smart contract is only based on data stored on the Ethereum blockchain. But there is a workaround: the database (in our case Ethereum) can contain so-called oracles — trustworthy parties that collect data from the “outside world” and send it to the smart contract. For more accuracy, it is important to select the broadest possible spectrum of independent oracles in order to minimize the risk of collusion.

A Smart Contract is just a piece of code

To gain a better understanding of this, we recommend that you take a look at this explanation on Medium: “A Smart Contract is a piece of code in itself. The result of this code should be an agreement between all participants in the system regarding the account balance. It follows that a smart contract cannot work with the money that is not in digital form. Without a suitable payment system (e.g. Bitcoin, Ethereum or central bank currency) Smart Contracts are useless.”

Smart Contracts in Tennessee

Storing data in a blockchain is now legal in Tennessee. We are some of the basic conditions prescribed by law:

  • Entries or contracts that are secured via the blockchain are recognized as electronic records.
  • Property rights of certain information stored on a blockchain must be protected.
  • A Smart Contract is considered to be an event-driven computer program running in an electronic, distributed, shared and replicated ledger used to automate transactions.
  • Electronic signatures and contracts secured by blockchain technology have the same legal status as traditional types of contracts and signatures.

It should be noted that this definition of a smart contract is very clear and understandable. Unfortunately, however, there are still issues that have not been addressed:

  • How can smart contracts and traditional contracts have the same legal status when the functionality of a smart contract is much broader? More specifically, it implements actions that a classic contract can only secure.
  • How is the digitization of assets carried out?
  • Do they provide any conditions to the source code of the Smart Contract or a normative review that is executed to minimize the risk of errors?

The problem is not with Smart Contracts, but with laying the foundations for their successful application.

Unfortunately, it is impossible to build unified smart contract-based relationships at the expense of official regulators recognizing the technology. For example, you cannot sell your home through a smart contract if there is no regulatory basis that considers the following:

  • The specified blockchain platform on which the smart contract functionality is good enough to enable wider use
  • The way assets are digitized. It’s not just digital money that’s used to execute transactions, it’s all valuable information, such as ownership. For example, you can prove that you own an apartment because it is traceable on the blockchain.
  • Who is the authorized party/oracle that collects external data and delivers it to the Smart Contract? In the case of flats, for example, this could be the notary who confirms parameters such as ownership, its condition, existence, and others.

Photo by Joshua Sortino on Unsplash

It’s true: A Smart Contract itself is a piece of code and lens — no problem either. What is a problem, however, is that a decent bear market must be created in order to successfully integrate Smart Contracts into everyday life. For this, a mechanism must be created and made available that enables the connection of two gear wheels:

  • Smart Contracts in a digital, decentralized and trustless environment
  • The real world, in which we mostly deal with top-down access to which regulators, lawyers, and courts belong.

In conclusion, we can, therefore, say that governments cannot simply adapt smart contracts on the basis of existing law. Then a smart contract would no longer be a smart contract. There is no problem with blockchain-related technologies becoming legally binding, but it should not violate the main concept of decentralization.

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