Smart Contracts vs. Smart Legal Contracts: Use Cases and Efficacy
As noted in our previous articles, for entrepreneurs, freelancers, small and medium businesses, it’s crucial to be able to form and sign contracts quickly. The use of new technologies makes it possible these days, with innovations such as smart contracts and smart legal contracts not just speeding up legal procedures but also improving copyright and intellectual property (IP) protection.
In this piece, we’ll dive deeper into the difference between smart contracts and smart legal contracts and find out when and how you can use each.
Three components of smart contracting
A smart contract is a computer program designed to run a distributed ledger or blockchain only after it is triggered by some event. If not getting into IT terms, it works like a coffee machine — you select a type of coffee you want, thus coding the machine on a specific outcome, then, by inserting coins, you trigger the event of payment. And here you go, rewarded with your morning coffee jab.
The catch here is that smart contracts are captured in code that automatically performs all obligations set by the parties in their legal agreement.
Once the smart contract code is uploaded into the blockchain, the only actions possible with it are those dictated by the logic inserted in the code. It makes the contract immutable. Due to their immutable nature, smart contracts have been gaining more popularity in the business community.
Blockchain technology makes it possible for users to make the legal side of the business more efficient both in terms of time consumption and economy. Smart contracts only control the execution of certain conditions predetermined by human lawyers, which significantly reduces the chance of an error.
The whole process of smart contracting consists of three components.
Those are:
- blockchain that serves as a transition record and a storage place for the smart contract code
- a certain value of funds transferred through the chain
- and the smart contract itself, which sets all conditions and triggers outcomes when the value is transferred.
So a smart contract is not law. They are made within the existing legal system.
What we need to understand here is that the contracts themselves are just a piece of code that has no means of knowing whether an enforceable legal obligation has been validly created.
Smart legal contracts, on the other hand, are legally binding digital agreements that can connect their terms and the performance of its obligation to external sources and software systems.
The Accord Project makes it clear that, although a smart legal contract can use smart contracts via blockchain technology, a smart legal contract can also be created using traditional software systems without the use of blockchain.
Making the legal side of the business more efficient
Within a supply chain, smart contracts can prove to be very useful on several occasions. This is especially relevant to a freelance designer, who needs to, for example, send his CAD files to a manufacturer or contractor:
- As a smart contract operates within a blockchain, it makes it possible to record all ledger entries. This is useful when transferring your CAD files and seeing at what stage the production is or where exactly things started to go wrong.
- A party could use a smart contract as a means to automatically release payment when all conditions are met. For example, when a manufacturer is satisfied with the CAD drawings, they automatically transfer money to a designer’s account.
- Smart contracts may work as technical tools that may assist in production. For example, a temperature-sensitive sensor may flag for human intervention. This would allow manufacturers to swiftly take action in case of an emergency or conduct an investigation to figure out what exactly went wrong.
How smart contracts operate
Smart contracts start performing the concluding part of the agreement only after they are triggered by a certain event, such as payment. To register one, they use “oracles” to receive information about the world around them.
Oracles can both provide information for smart contracts coded into blockchain (“inbound oracle”) and make it possible for them to send data to the world outside the ledger (“outbound oracle”). This is how the Internet of Things (IoT) concept is supposed to work.
For example, you may get access to a certain item inside a locker only after you trigger the lock to open by paying for the item. Oracles may be connected to online data sources or sensors, triggering events depending on, for instance, stock prices or traffic jams.
Humans also can act as oracles. But the more people are involved in the process, the greater the chance of human error, which is a risk to be considered.
On the other hand, a human operator can quickly adjust the terms and requirements of a contract if needed. But to ensure that the system properly “understands” the changes, the operator must be keen on cryptography. And here come the vulnerabilities of the system.
Limitations to consider when using smart contracts
Despite the fact that properly made smart contracts can significantly increase the speed of production, the concept contains a crucial disadvantage: smart contracts are very hard to make. Sometimes an untrained person may have a hard time understanding a regular, paper-written contract because of the specific slang and a variety of judicial terms.
When it comes to coded smart contracts, one needs to be able to compose the correct computer code as well, which may be challenging. There is also the possibility of errors in code and bugs that may make the whole system inoperable.
Another issue is that a non-coder can’t read it. Thus, an average businessman usually cannot verify whether all the conditions of a text-based contract are transferred into the code. This makes the whole process even less credible.
Probably the most important factor preventing smart contracts from becoming the world’s best contracting tool, at this point, is the fact that many countries do not view them as legally binding.
But some countries, like China, actively use it in their judicial system, which shows that the technology is likely to develop and expand in the near future.
Last but not least is the immutability of smart contracts. Once they are uploaded onto the blockchain, it is impossible to add anything to the terms of the agreement.
Ricardian smart contracts are the key
Ricardian smart contracts are both machine and human-readable. Using them makes it possible to license products and conclude agreements (i.e., NDAs) faster and easier.
CADChain’s legal department works in tandem with the software development team to create Ricardian smart contracts that are legally binding and comfortable to use even by non-lawyers. This is an unprecedented development that will make it easier for entrepreneurs, small and medium-sized businesses to take care of licensing in an automated fashion.
Thus, sharing CAD data with various customers and getting paid each time — while preserving the IP rights, protection of the proprietary code in CAE and its licensing or re-usage of older CAD files (for example, blueprints of older 3d printers) — would allow design engineering companies and independent specialists for an easy monetization strategy.
As the Chinese system has already adopted smart contracts, we seek to create a use case in the EU, making it liable in the European Judicial system.
By doing so, it will become possible to ensure that users can sublicense their CAD intellectual property to multiple parties in an automated fashion, without having to spend huge amounts of money on lawyers and coders.
