SMART CONTRACTS AND BLOCKCHAIN IMPLICATIONS

Smart contracts associated with blockchain are nothing new. Indeed, first experimental forms of smart contracts already existed in the 1990s. These experimentations enabled to make the smart contract idea real. This innovative idea began in the mid-1970s, but when there was no support of advanced technologies. Certainly, the blockchain phenomenon allowed and is still allowing to have guarantees of trust, reliability and security that in the past were necessarily delegated to a “third” figure.

According to the definition of the father of Ethereum (an open-source, public, blockchain-based distributed computing platform) Vitalik Buterin, the term smart contract defines a software, a code able of being executed without the control by a person. The substantial differences between a traditional contract and a smart contract is in the fact that the latter one is born from the execution of a code by a computer.

Smart contracts are the computer protocols created to facilitate, verify, or enforce the negotiation or execution of contracts. Nowadays, they support those professional realities that combine legal proficiency with robust technical and development skills.

More to the point, smart contract means the “translation” in code, or the “transposition”, of a contract. The purpose is to facilitate control over the occurrence of certain conditions and to automatically perform actions when the conditions set by the parties are fulfilled or verified. In other terms, the smart contract is based on a code that “reads” both the contractual clauses and the agreed operating conditions to be verified and this contract is executed automatically when there is agreement between the data referring to real situations and the data referring to the conditions and the arranged clauses.

It must be clarified that smart contracts are not traditional legal contracts, they are, instead, codes that can operate on blockchain, to ensure reliability and security.

The implementation of a blockchain system grants to contracts:

  • The legal value, and consequently the opposability (in consideration of the fact that the legal value cannot be denied to an electronic document, according to eIDAS - an EU regulation on a set of standards for electronic identification and trust services for electronic transactions in the European Single Market);
  • The certainty of enforcement of contractual obligations visible not only to the contractual parties, but also to all the hubs of the network of computers;
  • The transparency of contractual obligations for all participants of the blockchain;
  • Immutability of the recorded transactions and therefore the impossibility to modify or delete the contract;
  • The possibility of overcoming the problem of lack of trust, as the execution of contracts will rely only on the blockchain code and network.

SMART CONTRACTS ACCORDING ITALIAN LEGISLATION

In Italy, the Ministry of Economic Development has appointed a group of experts, entrusted with the development a national strategy.

In February 2019, through the Conversion Law of the simplification decree-law (Legislative Decree No. 135/2018), the Italian legislator provided a definition of smart contracts. According to the legislative text, a contract can be defined as smart contract only when it respects simultaneously the following characteristics:

  • It is a computer program;
  • It operates on technologies based on distributed ledger;
  • Its execution automatically binds two or more parts to condition defined by them.

The text also clarifies that a smart contract meets the requirement of the written form in the case of prior IT identification by interested parties, through a procedure that meets the requirements set by Agency for Digital Italy (AgID).

THE BLOCKCHAIN TECHNOLOGY

By enabling the distribution but not copying digital information, blockchain technology has created the supporting structure for a new type of internet. Originally designed for digital currency, bitcoins, this technology has strong potential to be exploited in other fields. The success of bitcoins has effectively shown that it is possible to create digital money by using the blockchain, to arrange and store reliable data. Therefore, it was only a matter of time and the potential of this system would be understood.

THE EUROPEAN UNION BLOCKCHAIN OBSERVATORY & FORUM

The European Commission has sponsored the initiative of the Blockchain Observatory and Forum, in order to accelerate innovation and development of the blockchain ecosystem within the EU and to help consolidate Europe’s position as global leader in this new technology.

This is a pilot project of the European Parliament. Among partners there are ConsenSys AG (general contractor), the University of Southampton, the Knowledge Media Institute at the Open University, University College London and the Lucerne University of Applied Sciences.

European Blockchain Observatory and Forum recently issued a report titled  “Legal and regulatory framework of blockchains and smart contracts”.

The innovative aspects of the blockchain are generally linked to some of its fundamental characteristics, such as decentralization, anonymity, immutability and automation. These features are often also the starting point for difficult legal and regulatory issues.

Considering the decentralization of the structure of the blockchain system, it can be difficult to ascertain who are the actors within the network, their location and their activities. In the event of disputes, this decentralization can lead to problems in ascertaining responsibility and in determining the jurisdiction of the disputes. In this regard, the blockchain industry has developed tools that can help authorities and blockchain companies to enforce regulations and identify the network participants.

With regard to Smart contracts, the European Union Blockchain Observatory and Forum, distinguishes between:

  • Legal contracts, with all the legal issues involved;
  • Smart contracts with legal implications, but with wider sense and use.

POSSIBLE ACTION WITH SMART CONTRACT THROUGH BLOCKCHAIN

Smart contract is not a real contract according the legal sense, but it is mostly a code that can be used in Blockchain for several reasons

  • Creation and transfer of digital assets;
  • Creation and execution of agreements between the parties;
  • Currency creation;
  • Governance (Decentralized Autonomous Organization) between different subjects.

THE MATTER OF TRUST AND THE DIFFERENT IMPLICATIONS

The main task of smart contracts is to provide a whole series of guarantees to the parties involved. This trust is based on three main elements:  the impossibility of modifying the code by which the contract is written; certification and reliability of data sources that determine the conditions of application; certification and reliability of reading and control methods.

As in traditional contracts, trust relies on a third party. However, while in traditional contracts the third party is a lawyer or notary, in smart contracts the third parties are the developers! These smart contracts receive the data that must be read, interpreted and certified on the basis of precise rules. For this reason, it is important that the smart contract is accurate both in the writing and in the management of the rules that determine its application.

These smart contracts are born precisely from the need to improve the performance of fallible and corrupt men, in the search for fairness and equity. In fact, one of the great benefits of this type of contract is precisely that, through them, “tamper-proof” agreements can be written, that is, not modifiable once they are distributed.

On the other side, this immutability may give rise other types of problems. For examples, in case of mistakes in writing or changing in the applicable contract law, or when events occur that influence the content of the rights and obligations of the parties. What remedies would the parties have since the system does not allow to modify the contract created? There are still doubts about this and other issues.

In its thematic report “Legal and regulatory framework of blockchains and smart contracts” the European Union Blockchain Observatory and Forum concludes, indeed, by saying that the use of smart contracts does not completely removed the problem of contractual liability or that of breach or execution of the contract. The problem of the difficult identification of the actors involved within a blockchain-based network is still present. It will be necessary to find a solution, not only in the relations between blockchain hubs and the State authorities, but also in the vertical relations among the blockchain hubs. Otherwise, the current system of parties protection may no longer be effective.

If you want to explore more about the blockchain topic, you can read our article about the importance of Blockchain.

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