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The conversation surrounding cryptocurrency and blockchain technology has led to an increased interest in smart contracts. In fact, smart contracts—self-executing agreements—live on blockchain-based platforms. But what are smart contracts, who uses them, and how are they written and enforced?
Smart contracts are, generally, sets of coded computer functions that trigger self-executing actions performed by computing nodes within a blockchain network. Blockchain networks are distributed, decentralized digital ledgers that enable users to record irreversible transactions. When choosing a blockchain platform on which to execute a smart contract, users may consider a multitude of factors regarding the specific blockchain platform, such as the degree of decentralization, transaction processing speeds and costs, energy consumption, and user friendliness.
Smart Contract Legal Issues
While smart contracts involve many technical coding components, parties to a smart contract should also consider the contract’s enforceability, conscionability, and practicality. The digital signature is a key stage in smart contract execution and enforceability, because smart contracts are not executed on paper. While digital (or electronic) signatures are recognized as legally valid under federal law, federal law does not relieve the parties to a smart contract from the obligation to satisfy elements of traditional contract law—offer, acceptance, and consideration.
A smart contract may need to meet state law requirements, which can vary by state. A smart contract can qualify as an enforceable agreement in a given state if it generally is:
- Permissible under the applicable statue of frauds
- Not on a smart contract or blockchain technology otherwise prohibited under an applicable state statue as a means to contract
- Comprised of the essential terms to form a contract albeit with the use of smart contract programming, e.g., if-then terms
Practical Considerations and Uses
In addition to legal considerations, smart contract considerations may also include:
- Efficiency – Smart contracts are autonomous by nature, with high-speed execution through self-executing terms or algorithmic logic
- Neutrality – Smart contracts may eliminate the need for negotiation, since they are self-executing
- Objectivity – The concrete nature of smart contracts can eliminate the “good faith” or “reasonableness” subjectivity that often exists in traditional contracts
- Modifiability and Terminability—Changing code—code that is generally anchored to a blockchain in unchangeable form—is more difficult than amending a written agreement
- Legal and Technical Complexities – Lawyers and smart contract coders may need to assist each other in marrying code programming with consideration of legal aspects to craft an effective smart contract
An appeal of smart contracts is their ability to facilitate complex agreements nearly instantaneously. A variety of industries—decentralized finance (DeFi) and decentralized autonomous organizations (DAOs), for example—currently use smart contracts. Smart contracts may also soon be used to establish and enforce IP agreements, execute transmission of payments in real time, provide evidence of creatorship, and manage digital rights. Smart contracts also have potential beyond these industries, such as the government, internet, management, and financial spaces, among others.
Common Law and Statutory Acknowledgments
Courts and state legislatures have recently begun to address smart contracts and the possible complications that they may present. However, there is still no universal definition of the “smart contract” term, and states are generally addressing this indirectly by enacting more industry-specific rules that account for smart contract utilization.
Legal and technical professionals still have roles to play in interpreting common law and statutory applications to smart contracts, in addition to drafting, as the legal recognition of smart contracts and the blockchain platforms on which they live evolves.
If you or your company would like to talk about smart contracts, please contact A.J. Zottola or Channing Gatewood. Learn more about Venable’s IP Tech Transactions services and subscribe to Tech Contract Quick Bytes.
Special thanks to Alastair Pearson for their assistance with this article.