Smart contracts can automate many different kinds of processes and operations, the most obvious being payment and actions conditional on payment. But the capabilities extend to many business and organizational activities.
A white paper by the Chamber of Digital Commerce with the support of the Smart Contracts Alliance presents 12 use cases of contracts for business and beyond.
Nick Szabo in 1996 described a smart contract as “a set of promises, specified in digital form, including protocols within which the parties perform on these promises,” a definition that still describes the term. Technology, however, has evolved, making new types of smart contracts possible.
Within a short time period, smart contracts will do more than automate aspects of the contract’s performance. “Contracts-for-difference” is an example of software continually adjusting balances and dispensing cash flows based on updated market prices.
But along with new opportunities come new challenges.
All smart contracts, regardless of their model, involve code, which may not always perform as intended. Messages can be delayed or interrupted, and data in transit can be corrupted. Private encryption keys can be compromised by hacking. The liability implications of such events must be considered.
The following are the 12 smart contract use cases.
Smart contracts can allow individuals to own and control their digital identity containing data, reputation, and digital assets. It permits individuals to decide what data to disclose to counterparties, providing enterprises the opportunity to seamlessly know their customers.
Counterparties will not have to hold sensitive data to verify transactions. This reduces liability while facilitating frictionless know-your-customer requirements. It also increases compliance, resiliency, and interoperability.
Smart contracts can digitize the Uniform Commercial Code (UCC) filing
and automate their renewal and release processes. They can also atomically perfect a lender’s security interest loan creation.
They can automate compliance with rules that require destroying records at a future date. They also make possible UCC liens that auto-release, auto-renew or automatically request collateral. In performing such functions, smart contracts reduce legal costs.
Smart contracts can simplify capitalization table management. They also circumvent intermediaries in the chain of securities custody and facilitate the automatic payment of dividends, stock splits and liability management, while reducing operational risks.
With securities on a distributed ledger, smart contracts digitize work flows.
There are considerations with securities.
The cryptographic signature of the State of Delaware can require enabling legislation to clarify that Delaware corporate law permits registration on a distributed ledger.
While issuers will welcome visibility into who owns their securities, some buy-side firms protect this information.
Smart contracts can streamline international transfers of goods via fast Letter of Credit and trade payment initiation, while enabling a greater liquidity of financial assets.
They can also improve financing efficiencies for buyers, suppliers, and institutions.
There are trade finance considerations. Industry standards for smart contract procedures are needed for wider acceptability.
The legal implications in case of an execution fall-out has to be determined, particularly in the cases of disputes and defaults.
The integration of settlement systems, technology requirements and off-chain ecosystems are important to success.
Smart contracts can streamline post-trade processes, removing duplicative processes executed by each counterparty for verifying trades, and conducting appropriate trade events. They enable a standard set of contract conditions and optimize the post-trade processing of over-the-counter derivatives. They also enable the real-time valuation of positions for monitoring and reducing errors.
When considering derivative smart contracts, it is important to address protocol changes related to regulatory reform.
Financial Data Recording
Financial organizations can utilize smart contracts for accurate, transparent financial data recording. Smart contracts allow for uniform financial data across organizations, improving financial reporting, and reducing auditing costs.
By improving data integrity, smart contracts support increased market stability. They also reduce accounting costs by allowing cost sharing among organizations.
Interoperability among the distributed ledger network and legacy systems is important in financial reporting.
Smart contracts can automate mortgage contracts by automatically connecting the parties, providing for a frictionless and less error-prone process. The smart contract can automatically process payment and release liens from land records when the loan is paid.
They can also improve record visibility for all parties and facilitate payment tracking and verification. They reduce errors and costs associated with manual processes.
Digital identity is a key requirement.
Land Title Recording
Smart contracts that facilitate property transfers can deter fraud, improve transaction transparency and efficiency, and strengthen confidence in identity. They also reduce auditing costs.
Common protocols need to be developed for electronic record filing.
Smart contracts can provide real-time visibility for every step in a supply chain. Internet of Things devices can record each step as a product moves from a factory floor to the store shelves.
They facilitate granular-level inventory tracking, benefitting supply chain financing, insurance, and risk. Such enhanced tracing and verification reduce the risk of theft and fraud.
The identities of supply chain players have to be attested over time, including companies, institutions, individuals, sensors, facilities, and products.
Smart contracts can improve the disjointed car insurance process. A smart contract can record the policy, driving record and driver reports, allowing Internet of Things-equipped vehicles to execute claims shortly after an accident.
They automate claims processing, verification, and payment. Each policyolder’s repository includes driving record, vehicle, and accident report history. Eliminating duplicated reporting will yield savings.
Cross-industry collaboration is needed to address technological, regulatory, and financial challenges.
Smart contracts can improve clinical trials through increased cross-institutional visibility. Privacy-preserving computation improves data sharing between institutions while automating patient data.
They can streamline processes for trials, improve access to cross-institution data, and can increase confidence in patient privacy.
Authentication, authorization and identity remain open issues for smart contracts executed on blockchain-enabled networks.
Smart contracts can facilitate the sharing of cancer data. They can facilitate the patient consent management process and aggregate data contribution and data sharing while protecting patient privacy.
New forms of blockchain technologies may be needed to provide real-time access and protection of data confidentiality.
Considerations About Smart Contracts
The white paper examined how smart contract code affects legal analysis.
When the code becomes the contract, resulting in a separate form of smart contract, the application of contract law can become complicated.
Smart contracts will not displace the long-standing pillars of contract law (including offer, acceptance, and consideration). But for smart contracts written entirely in code, courts will face challenges in applying contract law to determine when or whether a contract has formed, whether a party has met its obligations, whether a party has breached, etc.
Contract law developments in the context of online agreements provide guidance for how contract law will apply to smart contracts.
Over the past 10 years, courts have accepted electronic contracts in financial services.
Courts have also recognized clickwrap agreements as enforceable forms of contracting.
Contracts that should be straightforward include insurance contracts, escrow, and royalty distributions. Other contracts can involve more subjective judgment that will make an automated performance more challenging.
It may be difficult to develop contracts where the situation calls for reversibility of transactions, subjective analysis, programming of complex or nebulous principles, or extensive interaction among a blockchain and the outside world.
The parties also have to agree on how the information will enter a blockchain. In some areas, an outside actor will have to be trusted.
In the context of disputes, competing concepts will determine the amount of involvement of courts and lawyers. Despite the certainty afforded by a smart contract, contract law must have a level of flexibility to manage subjective issues.
Coders will be challenged to build fair dealing, good faith, and other subjective concepts into smart contracts.
While smart contracts will reduce demands on manpower, regulatory oversight will likely always be needed. Interpretation of a smart contract code will require a new regulatory skill set.I
Images from CDC and Shutterstock.
Last modified: March 4, 2021 4:52 PM