They’ve become something of a buzzword in recent years, but smart contracts are dramatically changing the way lawyers negotiate terms of agreement.
The Covid-19 pandemic led organisations from every sector to re-evaluate their processes and business models more than they ever had before. The use of distributed ledger technology (DLT), such as blockchain, accelerated significantly, as companies from the financial, property and legal services industries moved to digitise elements of their work.
Paper-based contracts are time-consuming and expensive to create. They’re susceptible to tampering and forgery, and lack transparency because they don’t include time logs. Increasingly, parties are making use of smart contracts to streamline agreements and minimise friction points.
In the years to come, lawyers will continue to encounter DLT and smart contracts as part of their work. Here’s everything you need to know:
What are smart contracts?
Picture the way a vending machine works. A customer will enter a certain amount of money, and the machine is pre-programmed to dispense their chosen item without the need for anyone to operate it. That’s often cited as an early example of a smart contract.
Today’s smart contracts are more sophisticated because they use blockchain. Essentially, they’re self-executing digital contracts, with the terms of agreement between parties written directly into code. The code uses blockchain technology to create a decentralised ledger that controls execution and makes contractual transactions trackable and irreversible.
Smart contracts reduce human intervention considerably and can police themselves if both parties are compliant with the terms. If there’s a breach, the contracts can penalise the offending party too (such as issuing a refund automatically if a vendor doesn’t deliver by the agreed deadline). The only way to make a change is to add another block to the existing chain with the mutual consent of all parties.
Some of the platforms facilitating smart contracts include Ethereum, Aeternity, Azure Blockchain Workbench, IBM Blockchain Platform, Corda and Hyperledger.
What are the benefits?
Because they use data encryption, smart contracts are tamper proof, making them a highly secure alternative to paper-based contracts, so they’re perfect for high risk environments, such as financial, property and legal services. Automation of the contract lifecycle and self-enforcement of capability speeds up the process considerably and makes it less prone to human error. And there’s a reduced dependency on intermediaries between the contract counterparts, which makes smart contracts highly cost effective.
There’s also higher transparency involved with smart contracts, and a lower execution risk. Any amendment requires the mutual consent of all parties, so there is no scope for manipulation of any individual.
Are there any drawbacks?
As always, there’s a flipside. Smart contracts do have the potential for over-automation of elements, which can restrict flexibility and discretion. Sometimes parties may want to create a relational contract instead of a transactional one. There may also be a necessity to pre-fund accounts due to the automation of movements of value.
Contracts are often intentionally ambiguous to leave room for the benefit of interpretation. With smart contracts, participants need to agree on “specific data”, such as location and time surrounding operational practices for the involved parties, and logic parameters, such as what type of rounding the smart contract will act on. There are also issues around amendments applied during a contract’s lifetime. The code of a smart contract cannot be made to execute contradictory terms, so issues will arise when an older contract has irrelevant or inapplicable clauses that have been forgotten about.
How could they be used?
The use of smart contracts is expected to grow significantly in the years to come. The most straightforward applications are where contracts are narrow, objective and mechanical, with clearly defined outcomes, such as:
- Property rights – property owners could use blockchain architecture to bypass intermediaries and sell their properties in a transparent and immutable way to save on transaction costs.
- Electronic signatures – Blockchain-based smart contracts reduce the cost associated with e-signatures and makes the notarisation process more trustworthy through signature verification with time stamps.
- Digital identity – More than 1 billion people in the world currently lack an identity, which makes it difficult for them to access health and educational services, as well as open a bank account. DLT makes it possible for every human to have a unique identity, rather than the conventional methods of issuing identity cards or physical passports.
- Chain of custody – before evidence is presented in court, it is handled by multiple people and can easily be tampered with. Using blockchain technology would enable monitoring in real time by generating and tracking a unique evidence token for every item of data collected and stored.
- Intellectual property rights – blockchain-based smart contracts leverage non-fungible-tokens (NFTs), used to represent the unique property. Users can upload and register their work with time stamps on a public ledger to create proof of ownership.
A new way of thinking
Smart contracts won’t replace lawyers anytime soon, but it will change the way they operate, reducing the time spent on technical details, administrative tasks and risk assessment. Instead, they’ll be able to focus on operational strategies and getting the details of the contracts right in the outset, with far fewer cases ending up in court.
Although many interactions between companies have been digitised, they still revolve around paper contracts and a risk based approach to relationships. This can be rife with distrust and bias. But with smart contracts, the focus will be on outcome-based thinking. Contracts can exist within autonomous systems, taking paper workflows, human error and inherent biases out of the equation. Problems can be anticipated and eliminated before they occur.
Forward thinking legal firms are embracing change and their businesses are benefiting greatly.
By bringing in simple, user-friendly solutions like Thirdfort for compliance management, these firms are successfully navigating the evolving regulatory landscape with the tech they now need to stay compliant and speed up client onboarding times.
If you’d like to learn more about how your firm can automate AML and ID verification using Thirdfort, book a demo with one of our team here.
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