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As we argue in our blockchain explainer, replacing human-centric trust with blockchain technology could radically change how we interact. One of blockchain’s exciting applications is smart contracts.

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For most of our everyday, face-to-face transactions, there is no need for trust—not going to fork out for that doughnut and double-shot latte? Your caffeine dealer will happily keep them behind the counter. But what about when the transactions occur across long distances or involve complex supply chains?

A good example (and one recently addressed by an Australian entrepreneur, Emma Weston of AgriDigital) is the sale of grain: when a farmer’s wheat is dropped off at the silo, she can’t be certain when—or whether—she’ll be paid for it. The transaction is an exercise in trust, which can easily be broken. Time to call a lawyer?

Blockchain evangelists might respond with an emphatic “no!” because the blockchain is incorruptible and gives certainty about the ownership of the wheat. At Legal Economy, we think that the situation is more nuanced. Transacting parties are unlikely to be confident that their “smart contract” is truly a contract or a smart idea without legal review and advice.

So, lawyers, the contract might look a little different but there’s definitely work to be done.

What are smart contracts?

Smart contracts are pieces of self-executing computer code that record the terms of an agreement on the blockchain. Importantly, these pieces of code are not actually “smart”—they simply operate as they are programmed to—nor do they always constitute legally enforceable contracts.

What do they do?

Simply, when satisfaction of one condition of the smart contract is recorded on the blockchain, this triggers the automatic completion of another condition. (Read our Chain Reaction blockchain explainer for an overview of the decentralised, universal ledger in which the contract is stored)

While automatic transactions (like direct debit payment) are now the norm, smart contracts take advantage of the security and public nature of the blockchain to enable execution of more complicated agreements. The blockchain’s decentralised record of transactions is effectively inalterable and generally accessible, so both parties to a smart contract can relinquish trust in each other, or an intermediary, and instead rely on the automatic execution of their agreement by the code.

For example, AgriDigital’s smart contracts facilitate payment to farmers as soon as the buyer receives the grain, which removes trust from the equation. It’s said it ‘will save buyers time and money, de-risk financing for banks, and enable paddock to plate transparency for consumers’.

Where does this leave lawyers?

ASIC’s recent information sheet about distributed ledger technology (blockchain is an implementation of this technology), suggests that its large-scale adoption in Australia is a question of when, not if. However, given the disastrous launch of Ethereum's smart contract-based Decentralised Autonomous Organisation last year, widespread use is a way off. The use of blockchain and smart contracts in business clearly raises issues of strategy and compliance that will require legal expertise at all stages of its implementation.

As a cost-effective and efficient alternative to hiring lawyers to manage a transaction, smart contracts might pose a threat to the legal profession. All the same:

  1. standard-form contracts often only take transacting parties part of the way to agreement. A detailed analysis of use of standard-form contracts in the construction industry (an industry in which standard-form contracts are commonly used) in Australia conducted by Melbourne Law School in 2014 found that 84% of standard forms are amended. Transacting parties want their contract to reflect their deal, not the precedent deal. As soon as terms start to be amended, it’s a good idea to seek legal advice (and don’t try to adapt a standard form farm lease to fit a completely different commercial purpose!);
  2. transacting parties still need to be confident that their rights are protected and that they won’t be dudded by some automatic execution loophole–legal advice gives confidence (and, somewhat cynically, might present a deep insurance pocket if the “smart contract” does not achieve the intended result);
  3. someone still needs to draft the smart contract to start off with; and
  4. the Ethereum debacle shows that code is far from foolproof, and the question of what happens when things go wrong in smart contracts is by no means settled.

So, we think smart contracts need smart lawyers. Where an agreement is complicated, there will still be ‘a need for judgement which is still best done by humans’. At the same time, it’s interesting to think that smart contracts might first take off in unusual dealings like renting, selling or sharing between machines. Maybe the inevitable legal disputes about how smart contracts fit into the legal landscape will be resolved in these unusual contexts well before smart contracts become a part of everyday life.

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Written for Legal Economy Pty Ltd by Nicola Hard.  You can contact Nicola at nicola@legaleconomy.com.au.

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