Meticulously written, regularly updated and carefully maintained, business contracts of all kinds have been keeping corporate legal departments busy for decades.
Now, however, a tech-driven overhaul in the contracting process is on the horizon: The era of smart contracts is dawning.
Smart contracts are programs stored on a blockchain that run when predetermined conditions are met. They typically automate execution of an agreement between two or more parties without the need for an intermediary, such as an attorney.
Most industries are at least considering using smart contracts, and the few that are not risk falling behind in the next five to 10 years, says Ron Quaranta, chairman and CEO of the Wall Street Blockchain Alliance.
Quaranta, a member of the Emerging Trends Working Group for ISACA, a technology trade association, says smart contracts have been discussed for years and already are in use in some industries, including music, finance and logistics.
“Any industry that still has manual processes will, in my mind, begin to evolve to use smart contracts,” he says.
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How Smart Contracts Work with Blockchain
Smart contracts follow simple “if/when/then” statements written into code on a blockchain. “The blockchain is then updated when the transaction is completed,” according to IBM. “That means the transaction cannot be changed, and only parties who have been granted permission can see the results.”
For example, a musician may be awarded royalties automatically after meeting a certain number of plays on Spotify. In finance, smart contracts could be used to buy, sell and settle securities. And Home Depot uses smart contracts on blockchain to resolve disputes with vendors.
“We’re essentially allowing vendors to have visibility into our receiving, and they’re allowing us visibility into what they’ve shipped,” Brian Quartel, Home Depot’s director of financial operations, explains in a case study published by IBM. “It’s almost like a settlement is happening with every single transaction versus waiting six, nine, 12 months down the road.”
Blockchain and smart contracts could soon become more common in healthcare, given patient privacy laws such as HIPAA, and real estate, with its heavy reliance on contracts and other legal documents, Quaranta says.
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Smart Questions to Ask When Using Smart Contracts
Some questions remain about how smart contracts are defined and their legal standing. There are some potential pitfalls as well, including cybersecurity concerns and technical coding issues.
A smart contract, for example, was exploited in a hack of a decentralized autonomous organization that was launched in 2016 on the Ethereum blockchain. The hack shook up the Ethereum community and resulted in the network dividing into two blockchains: Ethereum and Ethereum Classic.
Quaranta says some attorneys will say that smart contracts are “neither smart, nor a contract.” While smart contracts were considered legal for certain transactions in the U.K. in 2020, they are not yet considered legal documents by U.S. courts.
Still, Quaranta says, “the pace of innovation leveraging smart contracts is accelerating. Those not aware of them need to get up to speed.”