PART 2 OF 6 - SMART CONTRACTS: ADVANTAGES & DISADVANTAGES

This is Part 2 of a 6-Part Series of Articles on Smart Contracts. The Articles are:

• Smart Contracts for Dummies
• Advantages and Disadvantages of Smart Contracts
• Smart Contracts Vs Traditional Contracts (The Law!)
• 20x Real World Examples of Smart Contract and Blockchain Uses
• Tokenization and Non-Fungible Tokens (NFTs): A Comprehensive Guide
• The Future of Real Estate: From Traditional to Tokenized Transactions (as a Property Attorney, I just had to include it)

As the Articles are posted, the Links will be included to enable the Reader to easily navigate between all six Articles in the Series. If you missed it, please see the introductory Article: Smart Contracts for Dummies

ADVANTAGES AND DISADVANTAGES OF SMART CONTRACTS

According to Geeks for Geeks, there are advanges and disadvantages to Smart Contracts and these include the following:

Advantages of Smart Contracts

1. Recordkeeping:?All contract transactions are stored in chronological order in the blockchain and can be accessed along with the complete audit trail. However, the parties involved can be secured cryptographically for full privacy.
2. Autonomy:?There are direct dealings between parties. Smart contracts remove the need for intermediaries and allow for transparent, direct relationships with customers.
3. Reduce fraud:?Fraudulent activity detection and reduction. Smart contracts are stored in the blockchain. Forcefully modifying the blockchain is very difficult as it’s computation-intensive. Also, a violation of the smart contract can be detected by the nodes in the network and such a violation attempt is marked invalid and not stored in the blockchain.
4. Fault-tolerance:?Since no single person or entity is in control of the digital assets, one-party domination and situation of one part backing out do not happen as the platform is decentralized and so even if one node detaches itself from the network, the contract remains intact.
5. Enhanced trust:?Business agreements are automatically executed and enforced. Plus, these agreements are immutable and therefore unbreakable and undeniable.
6. Cost-efficiency:?The application of smart contracts eliminates the need for intermediaries (brokers, lawyers, notaries, witnesses, etc.) leading to reduced costs. Also eliminates paperwork leading to paper saving and money-saving.

Disadvantages of Smart Contracts

1. No regulations:?A lack of international regulations focusing on blockchain technology (and related technology like smart contracts, mining, and use cases like cryptocurrency) makes these technologies difficult to oversee.
2. Difficult to implement:?Smart contracts are also complicated to implement because it’s still a relatively new concept and research is still going on to understand the smart contract and its implications fully.
3. Immutable:?They are practically immutable. Whenever there is a change that has to be incorporated into the contract, a new contract has to be made and implemented in the blockchain.
4. Alignment:?Smart contracts can speed the execution of the process that span multiple parties irrespective of the fact whether the smart contracts are in alignment with all the parties’ intention and understanding.

The following ideas are selected extracts from “An Introduction to Smart Contracts and Their Potential and Inherent Limitations” posted by Stuart D. Levi and Alex B. Lipton, Skadden, Arps, Slate, Meagher & Flom LLP in HARVARD LAW SCHOOL FORUM ON CORPORATE GOVERNANCE. The full Post is well worth a read (click the Link) and contains some examples of ideas that I have only eluded to here.

The Interplay between Smart Contracts and Traditional Text Agreements

One of the difficulties with discussing smart contracts is that the term is used to capture two very different paradigms. The first involves smart contracts that are created and deployed without any enforceable text-based contract behind them. For example, two parties reach an oral understanding as to the business relationship they want to capture and then directly reduce that understanding into executable code. We refer to these below as “code-only smart contracts.” The second paradigm involves the use of smart contracts as vehicles to effectuate certain provisions of a traditional text-based contract, in which the text itself references the use of the smart contract to effectuate certain provisions. We refer to these as “ancillary smart contracts.”

Are Smart Contracts Enforceable?

That's an excellent question, isn't it? Please see Part 3 of this 6-part series when we will consider Smart Contracts and the LAW.

Challenges With the Widespread Adoption of Smart Contracts

The challenge to widespread smart contract adoption may therefore have less to do with the limits of the law than with potential clashes between how smart contract code operates and how parties transact business.

1. How Can Non-technical Parties Negotiate, Draft and Adjudicate Smart Contracts?
2. Smart Contracts and the Reliance on “Off-chain” Resources

• First, smart contracts do not have the ability to pull data from off-chain resources; rather, that information needs to be “pushed” to the smart contract.
• Second, if the data at issue is in constant flux, and since the code is replicated across multiple nodes across the network, different nodes may be receiving different information, even just a few seconds apart.
• Given that consensus is required across the nodes for a transaction to be validated, such fluctuations can cause the condition to be deemed “not satisfied.”
• Contracting parties will be able to solve this conundrum by using a so-called “oracle.” Oracles are trusted third parties that retrieve off-chain information and then push that information to the blockchain at predetermined times.
• Although oracles present an elegant solution to accessing off-chain resources, this process adds another party with whom the parties would need to contract to effectuate a smart contract, thus somewhat diluting the decentralized benefits of smart contracts.

3. What is the “Final” Agreement Between the Parties?

• When analyzing traditional text-based contracts, courts will examine the final, written document to which the parties have agreed.
• In the case of code-only smart contracts, the code that is executed—and the outcome it produces—represents the only objective evidence of the terms agreed to by the parties.
• With respect to ancillary smart contracts, a court likely would look at the text and code as a unified single agreement. Contradictions?

4. The Automated Nature of Smart Contracts

• One of the key attributes of smart contracts is their ability to automatically and relentlessly execute transactions without the need for human intervention.
• However, this automation, and the fact that smart contracts cannot easily be amended or terminated unless the parties incorporate such capabilities during the creation of the smart contract, present some of the greatest challenges facing widespread adoption of smart contracts.

5. Amending and Terminating Smart Contracts

• At present, there is no simple path to amend a smart contract, creating certain challenges for contracting parties.
• Similar challenges exist with respect to terminating a smart contract.
• Projects are currently underway to create smart contracts that are terminable at any time and more easily amended.

6. Objectivity and the Limits of Incorporating Desired Ambiguity Into Smart Contracts

• It will take some time for those adopting smart contracts in a particular industry to determine which provisions are sufficiently objective to lend themselves to smart contract execution.
• As noted, to date, most smart contracts perform relatively simple tasks where the parameters of the “if/then” statements are clear. As smart contracts increase in complexity, parties may disagree on whether a particular contractual provision can be captured through the objectivity that a smart contract demands.

7. Do Smart Contracts Really Guarantee Payment?

• One benefit often touted of smart contracts is that they can automate payment without the need for dunning notices or other collection expenses and without the need to go to court to obtain a judgment mandating payment. While this is indeed true for simpler use cases, it may be less accurate in complex commercial relationships. The reality is that parties are constantly moving funds throughout their organization and do not “park” total amounts that are due on a long-term contract in anticipation of future payment requirements.
• Similarly, a person obtaining a loan is unlikely to keep the full loan amount in a specified wallet linked to the smart contract. Rather, the borrower will put those funds to use, funding the necessary repayments on an?ad hoc?basis.

8. Risk Allocation for Attacks and Failures

• Smart contracts introduce an additional risk that does not exist in most text-based contractual relationships—the possibility that the contract will be hacked or that the code or protocol simply contains an unintended programming error.
• Given the relative security of blockchains, these concepts are closely aligned.

9. Governing Law and Venue

• One of the key promises of blockchain technology, and by extension smart contracts, is the development of robust, decentralized and global platforms.
• However, global adoption means that parties may be using a smart contract across far more jurisdictions than might exist in the case of text-based contracts.

Conclusion

Like most things in life, there are obviously Pro's and Con's but, in my opinion, Smart Contracts are not only here to stay but will become an essential business tool. As mentioned in Part One of this series of Articles, Smart Contracts lie at the intersection of Law and Technology and anyone using Smart Contracts should absolutely ensure that they obtain the best input from experts in both fields!

Gareth Shepperson is an Attorney, Conveyancer and NFT Auditor.

Gareth is the Past-Chairman of the Property Law Committee and the Past-Chairman of the IT and LegalTech Committee of the PRETORIA ATTORNEYS' ASSOCIATION and Member of Exco of the GAUTENG ATTORNEYS' ASSOCIATION (Property Law and Marketing Portfolios) as well as a Past-Member of the Company Law Committee and Past-Member of the Property Law Committee of the LAW SOCIETY (LSNP).

Gareth heads the Blockchain Department at STEGMANNS INCORPORATED (Established 1890).