Smart Contracts

The Blockchain Research Lab works on identifying smart contract use cases across various sectors. Additionally, we closely pursue regulatory developments as we are working on the intersection and/or connectivity of smart contracts and legalese (LegalTech).

Smart Contract Use Cases

Smart contracts offer the potential of disintermediation and enable the automation of various processes. As blockchain provides the first secure application platform for smart contracts use cases and applications can be identified that potentially offer cost saving and new business models across industries. Some examples of potentially relevant and important use cases could be the management, routing and error checking of workflows between entities, the calculation and execution of payments and/or funds or the tracking of assets or the transfer and access to records and changes made to these records.

Decentralized car sharing / leasing. Cars are unlocked via smart contracts and payments are automatically calculated and paid based on predefined terms of a contract:

In order to develop or utilize a smart contract, the terms and conditions of an agreement need to be translated into code. In the deterministic code structure, all potential output capabilities need to be predefined and be agreed on. The application of smart contracts reaches from simple account transfers of cryptocurrency to applications within the Internet of Things (IoT) and smart property use cases. In a turing-complete environment, every possible use case can theoretically be built, reaching from a simple if/then-contract up to networks of smart contracts that act autonomously on a blockchain. The simultaneous use of various smart contracts theoretically enables very complex use cases.

One main obstacle of more complex smart contract use cases is the issue how information and events, which are not displayed directly on the blockchain, can be processed. A contract can instantly react to cryptocurrency being sent from one account to another, as the whole process is handled on top of the blockchain. If a smart contract needs to react upon the expression of an interest rate, it cannot simply gather the information by itself. By relying on outside information, a smart contract cannot run autonomously but needs an outside entity to provide information to the blockchain. Participants of a smart contract need to settle how outside information is being handled before uploading the contract code. For instance two contract participants could determine a dedicated entity to handle the processing of the code and updating of information. Smart oracles – or simply oracles – are entities that gather off-chain information and provide this information to smart contracts, which then execute their predefined logic. In the consensus-based network, every node has to agree on external data that is imported in order to trigger the execution of a smart contract. While the use of oracles offers a possibility to verify the data via various models and securely transmit information to the blockchain, any oracle solution acts as an intermediary. The existence of an intermediary does impede the desired benefits of a smart contract solution, as a possibly untrusted actor becomes involved and the immutableness and trustworthiness of a smart contract becomes doubtful. Additionally, the degree auf automation may decrease due to the use of an oracle.

With the invention of the blockchain, the formerly conceptualized idea of smart contracts can effectively be applied. Smart contracts enable the deployment of computer protocol on top of a blockchain. These blockchain-programs react on transactions and execute predefined contractual clauses upon the arrival of information. This allows the automation of processes across a blockchain. To date, various companies or foundations are working on the development of smart contract platforms. A widespread and extensive use of smart contracts cannot be observed to date, as technical challenges and regulatory uncertainty hinder the adoption of the technology. Once these challenges are overcome (at least to some extent), the use of the technology will likely spread at a rapid pace.

Representation of Smart Contracts as Legal Contracts (LegalTech)

To date blockchain (or blockchain-like) systems represent the only infrastructure solution, on which smart contracts can securely be executed. Therefore,  the respective technical and regulatory challenges of blockchain itself can also be adopted for smart contracts. To these outstanding issues (like scalability, shortcomings of consensus mechanisms and regulatory developments) additional challenges and issues regarding smart contracts are added.

Several technical aspects of smart contracts represent challenges for a broad implementation of smart contracts in the real world. The automated performance of predefined dependencies does contain an irreversibility of contract enforcement. Just like any other blockchain transaction, transactions can only be reversed via a hard fork or a soft fork. In a blockchain ecosystem, criminal or faulty contracts can easily be deployed on the blockchain, as comparatively small amounts of lost or stolen funds will not cause the network to undergo a fork to undo these transactions.

Smart contracts do not possess flexibility, i.e. their underlying code structure cannot be interpreted. Written law usually does implement a certain degree of flexibility, to be able to react on unpredictable circumstances, like the impossibility of contract execution due to death or destruction. Flexibility offers involved entities of a contract the ability to avoid the full anticipation of all possible outcomes. To date, smart contracts are not able to implement flexibility, as they only react on predefined code. Future developments like hybrid forms of legalese and programming code or contract templates might be able to offer some amount of flexibility.

As smart contracts represent an even newer technological innovation than blockchain, a regulatory framework does not exist to date. It is unclear how smart contracts are defined from a legal perspective and to what extent they can represent binding legal contracts. The term smart contract is somewhat misleading. A more fitting name would likely be smart agent or smart program, as contract agreements are one, but not all of the expressions that can be archived.

As assorted characteristics between smart contracts as computer code and smart contract as legal contracts can take different forms, Macey, 2016 identifies four to five different possible versions, or expressions of smart contracts:

  1. Executable Computer Code: Not a contract, as the code solely flows instructions.

  2. Executable computer code with legal rights and obligations: Close to an actual contract by providing an interpretation of the expected execution of the code. The legalese is used to reflect the code.

  3. A legal contract with full execution of code implementation: The logic reflects the legalese.

  4. A legal contract with partial code implementation: A legal contract is analyzed and the parts that can be automated are extended via programmable logic, while the rest of the contract remains to be legal prose.

  5. A legal contract with negotiation: Executable logic is not provided but the editing and negotiation in a shared / live environment.

Learn about the disruptive use cases of smart contracts

Read more about the potential use of smart contracts in an interview Dr. Fiedler held with nextMedia.Hamburg.

 

Link to the Interview

 

For more information on the use of smart contracts, do not hesitate to contact us.