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08 May, 2024

Unforeseen Boundaries: Exploring Legal Issues and Challenges in Smart Contracts

Legal smart contracts aim to fundamentally enhance business relationships and transactions. The global market for smart contracts is projected to reach $1,460.3 million by 2028. Utilizing smart contracts ensures transparency, traceability, and irreversible transactions within the blockchain. 

Despite their benefits, smart contracts also come with drawbacks. Fortunately, many of these limitations can be resolved with the right solutions. In this article, we will explore the main limitations of smart contracts and discuss ways to overcome them. Let’s begin by examining the context of this topic from the very beginning.

What Are Smart Contracts In A Nutshell?

Legal smart contracts are a kind of algorithm for specific actions integrated into the blockchain code. If the established agreements, which are spelled out in it, are followed, the sequence is automatically triggered.

For example, let’s take the simplest transaction – the process of buying and selling cryptocurrency between users. This process takes place according to the requirements of anonymity and is not regulated by intermediary organizations. This model is possible thanks to smart contracts, which prescribe a detailed algorithm of the transaction between two users. In addition, this eliminates the opportunity for fraud on both sides and makes it possible to conduct the transaction in a specific algorithm of sequential actions.

Legal smart contracts are not drafted by lawyers and are essentially software. Contract terms are translated into a code series of “if-then” functions. Once a condition is met, the smart contract automatically implements the next step necessary to fulfill the payment. Thus, the term “smart contract” refers to transaction protocols that automatically execute contract conditions based on a set of rules.

Industries Revolutionized by Smart Contracts: Beyond Finance

Smart contracts have transcended their initial association with cryptocurrency and are now transforming a multitude of industries. Here’s a glimpse into some key sectors embracing smart contracts and the exciting possibilities they unlock:

Supply Chain Management:

Imagine a world where every step of a product’s journey, from origin to shelf, is transparent and verifiable. Smart contracts can make this a reality. They can:

  • Automate logistics and payments: When goods reach designated checkpoints, smart contracts can automatically trigger payments to transporters or initiate customs clearance processes.
  • Ensure product authenticity and provenance: By recording data like origin, manufacturing processes, and ownership changes on a blockchain ledger, smart contracts can guarantee the authenticity of products and combat counterfeiting.
  • Improve traceability and visibility: Real-time tracking of goods throughout the supply chain becomes possible, enhancing efficiency and reducing the risk of delays or disruptions.

Healthcare:

Smart contracts can streamline healthcare processes and empower patients:

  • Secure medical record management: Patients can control access to their medical records using smart contracts, ensuring data privacy and facilitating secure sharing with authorized healthcare providers.
  • Automated insurance claims processing: Smart contracts can automatically verify and process insurance claims based on predefined criteria, eliminating delays and paperwork.
  • Clinical trial management: Smart contracts can ensure the secure and transparent tracking of data and participant payments in clinical trials.

Real Estate:

The traditional real estate market can benefit from the efficiency and security of smart contracts:

  • Automated property transactions: Smart contracts can streamline property sales and rentals by automating escrow services, title transfers, and rent payments.
  • Fractional ownership: Smart contracts can facilitate the fractional ownership of real estate, making it more accessible to a wider range of investors.
  • Enhanced transparency and security: Smart contracts can ensure all property details and transaction history are securely stored on a blockchain, reducing the risk of fraud and errors.

Government and Public Services:

Smart contracts hold immense potential for improving government efficiency and citizen engagement:

  • Automated issuance and management of licenses and permits: Smart contracts can automate the issuance and renewal of licenses and permits, reducing administrative burden and streamlining the process.
  • Secure voting systems: Blockchain-based voting systems powered by smart contracts can enhance the security and transparency of elections.
  • Social welfare distribution: Smart contracts can ensure targeted and efficient distribution of social benefits, reducing fraud and administrative costs.

Media and Entertainment:

The creative industries are also exploring the potential of smart contracts:

  • Fair royalty distribution: Musicians, artists, and content creators can leverage smart contracts to ensure they receive proper royalties for their work whenever it’s used or distributed.
  • Ticketing and licensing: Smart contracts can automate ticketing systems, eliminate scalping, and streamline licensing agreements for creative content.

These are just a few examples, and the potential applications of smart contracts continue to expand. As the technology matures and regulations evolve, we can expect even more transformative use cases to emerge across various industries.

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What Is So Challenging About Legal Smart Contracts?blockchain legal issues_LITSLINK

Although the concept of the legal status of smart contracts has been around for a long time, the real-world application has only recently become possible, thanks to the growth of blockchain development technology. Blockchain itself is usually defined as a decentralized digital registry in which transactions are recorded publicly in chronological order.

In its infancy, blockchain was a mechanism for tracking cryptocurrency, mainly bitcoin, but the technology is evolving to another level, which could facilitate many smart contracts business transactions online. 

First, to determine the prospects for the use of smart contracts, it must be assumed that they are based on distributed ledger technology. This implies a database of digital elements and assets distributed across different geographical areas among data centers or individuals. Each of these network participants has its own copy of the registry, identical to all other copies. If changes are made to the registry, they are immediately reflected in the copies of all participants.

This means that the use of legal smart contracts is only appropriate when a public database is used, in which changes are made by the users themselves, without the involvement of an intermediary.

Another aspect of the implementation of smart contracts is the use of a private key to access digital assets. If there is no need to use such a key in a particular case, this points directly to the point that the use of a smart contract makes no sense.

For example, legal smart contracts can automate the fulfillment of terms, but technology is unlikely to replace lawyers anytime soon. They can indeed make transactions cheaper and eliminate specific points of contention between parties, who have their own terms to accompany the agreement. However, to automatically execute the terms of the contract, they must be properly validated and verified.

Moreover, smart contracts cannot be used in complex situations. Yes, they can indeed speed up the transfer of funds to designated accounts when the exchange price reaches a certain value, but in more complex supply chains it won’t work that way.

For example, when using a smart contract to unlock funds when goods arrive at a specific location to objectively verify delivery, there is a lot of interrelated and potentially costly technology to consider. For example, when shipping goods, you have to install RFID and other necessary software to write it into a blockchain, which can add to the amount of time it takes to prepay. So legal smart contracts will only be useful in situations where the terms can be clearly established. But many contracts are written with vague terms – just to give the parties some flexibility.

Problems And Limits With Smart Contractsblockchain legal issues_LITSLINK

Having analyzed the whole essence and history of smart legal contracts, we have collected the main limits and problems below.

Lack Of Legal Regulation Of Smart Contracts

Purely theoretically, the use of smart contracts right now, without a legal framework, is allowed based on such legal principles as “freedom of contract” and “everything that is not expressly forbidden is permitted.” But show us an entrepreneur who will be delighted with the predictable reaction of the fiscal authorities to the use of such newfangled mechanisms in economic activity. This means that he will think about it three times beforehand and will slow down.

On this basis, it is inadmissible to refuse to solve the remaining problems with the introduction of the legal status of smart contracts. It may happen that the issue of legal regulation will be resolved at one point, but other difficulties will “pop up” from where they were not expected.

No Connection To A Particular Territory Or Jurisdiction

It is not possible to determine in which country the smart contract or assets are located. Which smart contract laws are covered by this ill-fated law, and to which jurisdiction does it belong? Through the prism of such questions in society, there is an opinion that it is impossible to use smart contracts in principle, or the need to continue to manage them manually. This is a serious issue. 

In the execution of the legal status of smart contracts, there can be no dispute a priori, which leads to a question “Are jurisdictional issues so important in practical terms?”

Using Cryptocurrencies As A Unit Of Account

This problem is closely related to smart contracts issues of legal regulation and, at first glance, seems intractable because it is impossible to use a “cash surrogate” in legal transactions. There is a solution. 

In particular, developers on their platforms are issuing stablecoins (special tokens using blockchain technology). According to some of them, like Tether, such digital assets are tied to the U.S. dollar exchange rate, fully secured by it, and bank accounts with the corresponding fiat reserves are regularly audited.

When such stablecoins are used, tokenized dollars are moved from one person to another. In simplistic terms, the use of stablecoins can be seen as a way of transforming fiat funds into cryptocurrency and vice versa. Of course, it is too early to claim that stablecoins are a reliable way to convert fiat money into digital assets, because they have appeared recently, but at the same time, this tool has certain prospects.

At the moment, the most famous are the following stablecoins: Tether USDT, USD Coin, TrueUSD, Gemini Dollar.

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Problems Associated With The Legal Construction Of Traditional Contracts 

Let’s assume that we have already solved all the other problems. We have legalized crypto, passed smart contracts laws, and built infrastructure.

Ornate twisted lexical turns and complex legal principles constructions are fine in some cases, for example in court or when the client needs to throw dust in the eyes. But they are not the best option when working with automated systems and mathematical algorithms. The simplicity of a smart contract stems from the mechanism itself, where all the steps are clearly defined and deterministic.

The principle of determinism means that the processing of specific data in a legal smart contract will always lead to a specific, unambiguous result. The program in legal smart contracts has the function “If payment is overdue, then the car door is automatically blocked”.

That’s why we already know when writing traditional contracts, you should avoid unnecessarily complicated constructions and ornate expressions. This may well be an excellent and effective first step for future evolution.

The second step may be a gradual revision of the terms of contracts, transforming their provisions into logic and mathematical formulas. Finally, use simple, clear vocabulary and create a structure for contracts that is flexible and as adaptable as possible to the new environment.

Lack Of Necessary Infrastructure And Extensive User Support

It is assumed that in order to execute legal smart contracts, some kind of information from external sources will be needed, such as air temperature, etc.

If a smart contract is performed automatically without human involvement, following algorithms already laid down, then there is a problem with obtaining such information and – especially – confirming its validity.

Oracles programs have been proposed to solve this problem, but there are many other concerns: lack of proper infrastructure, poor public awareness of blockchain technology, and unpopularity and mistrust of cryptocurrencies among the public.

Most likely, the solution to these difficulties is a matter of time, but it is necessary to work now to popularize cryptocurrencies and build trust in them.

Defining The Programming Language Of Legal Smart Contracts

Today, one of the most common languages for writing smart contracts is Solidity, which in particular is used in the Ethereum environment. Although this language is at an early stage of development, it is already possible to create a variety of contracts with its help. 

The capabilities of this programming language give rise to scientific discussions about its turning completeness — an ability to program any computational algorithm. Although the arguments against the turning-completeness of Solidity are very strong. Also, we all should remember that this language is still under active development, and its specific area of application does not provide a solution to every problem.

However, to date, the opportunities provided by such languages are open only to programmers, which does not greatly facilitate the work of smart contract lawyers who do not have programming skills.  

The Future of Smart Contracts and Ways of Solving Current Challengesblockchain legal issues_LITSLINK

Thus, assuming that in the future the use of legal smart contracts will be massive, we should already think about simplifying the tools for their creation. Perhaps it would be appropriate to develop a consistent, unambiguous, and, what is an important, easy-to-use special programming language for legal smart contracts or special tools to translate familiar to many contracts into the logic of a smart contract.   

At the same time, there is already a real opportunity to create legal smart contracts aimed at collecting cryptocurrency (secure pooling of funds) for specific purposes. This, in particular, can already be done on the Trustee platform, where any user without any special knowledge and programming languages is able to generate and upload a smart contract to the network in just a few minutes. Using the platform is convenient, and does not require additional costs and additional procedures.

In any case, there is no doubt that smart contracts are changing our lives for the better – they are becoming safer and more secure in the digital realm. Smart contracts will continue to evolve and improve, and maybe very soon we will see the most invulnerable smart contract in the world. It will show that nothing is impossible.

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Wrapping Up 

A legal smart contract is a code in blockchain technology. A virtual machine executes it after receiving a transaction with the right parameters.

With the development of computer and blockchain technologies, the idea of automatic contracts that are self-executing using algorithms has become popular, and today with many legal nuances, but still implemented, in particular on the Ethereum platform.

The attitude of regulators in different countries to such “smart” agreements differs, depending on the regulation of cryptocurrencies in the relevant jurisdiction and the peremptory norms of law and order. Nevertheless, the future of smart contracts seems quite intriguing.

 

 

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