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While the term smart contracts may have us drawing associations with AI and machine learning, there’s no real relation between these technologies. Let’s take a moment to debunk the myths of smart contracts and explain how they may be used now and in the future.
Author: Álvaro Martín, student and class representative of the Doble Máster en Abogacía y Asesoría Jurídica de Empresas
The emergence of smart contracts has attracted a lot of interest from the legal community in recent years. This is no surprise. Smart contracts no longer have a very narrow scope of application, and the technology is going through a phase of rapid technical development. This has made it possible to conceive of new ways of interacting with third parties, potentially revolutionizing the practice of law.
However, despite the great advancement that this could represent for the work of lawyers, people sometimes overlook the fact that the term “smart contract” refers to an exclusively technological concept which has nothing to do with legal reality. In other words, when we talk about smart contracts, we are not talking a priori about a way to revolutionize private-legal relations, but simply about software.
The term “smart contract”, first quoted in Extropy magazine by Nick Szabo in 1996, was originally used to define “a set of promises, specified in digital form, including protocols within which the parties comply with these promises.”[1]
These days, in the context of blockchain technology, a smart contract can be defined as computer code that is incorporated into the blockchain to facilitate, execute and enforce the terms of an agreement between parties who do not fully trust each other.[2] This computer code is structured as a set of conditional instructions that determine the execution of a specific function when a previously established condition is met. In technical terms, this is known as an ifs + thens structure, i.e. “if situation A, then do B.”[3]
This can break the assumption many of us have when we are first told about smart contracts. The term can make us imagine extremely complex contracts or mistakenly relate this concept to others such as artificial intelligence. Nothing could be further from the truth. A program of this nature cannot be described as intelligent, since it will simply execute, or not execute, its contents according to instructions given beforehand, without having the capacity to reason or react to the situation.
Why would anyone be interested in using such a computer program? The use of blockchain networks allows the execution of this type of software to be automatic and immutable, which makes them resistant to manipulation attempts. The information contained in these smart contracts becomes indelible and unalterable the moment they are incorporated into the blockchain.
In the Spanish legal practice, there have been various attempts to approach smart contracts in different ways, but there is no consensus on whether they can be, in themselves, a private law contract. There are two main schools of thought regarding smart contracts, namely the denial theory and the code is law position.
Denial Theory
The denial theory deals with the purely technological concept of the smart contract. Its advocates understand that it is not possible to talk about smart contracts as a legal reality. According to this theory, the software of a smart contract will have no relevance from the point of view of contract law, but the legal consequences of its execution will always depend on a traditional, physical contract.
Code is Law
This theory, radically different from denial theory, postulates that software should be understood as a set of rules that regulates the creation of rights and contracts in virtual space. Just as in physical spaces we have legal codes and other provisions, virtual spaces use computer code as regulators.
The code is law position, although extreme in its approach, allows us to consider the possible legal consequences that an intelligent contract could have. What may appear to be a simple program with basic conditional instructions could be used, for example, to buy or sell shares of companies on the stock exchange in accordance with their quoted price.
Until now, Spanish legislation on electronic contracting has been limited to conceiving of an electronic contract as a specific way of documenting an agreement in order to facilitate its subsequent consultation. A proposal to carry out contracting only using computer code (a legal smart contract) would be difficult to fit in with Law 34/2002, of July 11, on information society services and electronic commerce (LSSICE).
However, smart contracts are already here and they continue to push towards mass adoption. It’s possible that in a few years we will accept new forms of procurement. But for the time being, smart contracts will remain neither contracts nor smart.
Álvaro Martín is a current student and class representative of the Doble Máster en Abogacía y Asesoría Jurídica de Empresas at IE Law School. He is a Law and Business Administration graduate from ICADE Business School (E-3) and a member of ELSA. Álvaro’s passion for law and business has seen him take part in multiple international experiences, such as an exchange semester at Singapore Management University and a Business, Banking and International Relations program at Fordham University, New York. Having interned at a REIF and several law firms, Álvaro is driven to pursue a legal career specializing in corporate law and M&A.