A recent report by the UK’s Law Commission concluded that the English legal framework is clearly able to facilitate and support the use of smart contracts.
Since the English and Irish legal systems are broadly similar, this bodes well for Ireland. There is a growing awareness about the vast potential for smart contracts, and this extends beyond the by now well-known Decentralised Finance ("DeFi") and the more recent Non-Fungible Tokens ("NFT") industries.
What are smart contracts?
Smart contracts are computer code that automatically executes when certain predetermined conditions are met. Although they do not necessarily need to function on a blockchain, they have become synonymous with blockchain technology due to the security, transparency and verifiably which blockchain provides. Because of their flexibility, blockchains with smart contract functionality, such as Ethereum or Solana, have become the building blocks for a new industry of decentralised applications – sometimes referred to as "Web 3".
How can you use smart contracts?
Apart from offering developers the capability of creating new industries such as NFTs, it is becoming increasingly common for business to explore integrating smart contracts into aspects of their own operations to improve efficiency and value creation.
One example cited by the Law Commission is Trakti Ltd who use a B2B smart contract running on Ethereum to monitor the execution of a cloud IT service with agreed KPIs. Penalties or bonuses are automatically assigned subject to data collected from a KPI dashboard and computed to a weighted average. If performance is 30% below the agreed target the contract automatically terminates.
Use Case Example: Supply chain management
Using a smart contract has the potential to drastically reduce paperwork, while simultaneously improving transparency and traceability:
- Reducing the need for elaborate paperwork as goods progress from one location to the next;
- Using IoT devices to detect conditions which are recorded on the blockchain, such as the opening or closing of containers during transit, or large temperature changes, thereby helping prevent protracted disputes;
- Ensuring the authenticity of goods by tracing their provenance, thereby protecting against counterfeiting;
- Promoting CSR goals by ensuring supply chain traceability and protecting against modern slavery.
What to look out for?
Although smart contracts have huge potential, there are a few issues which should be considered and resolved before pressing ‘go’:
- ‘Oracles’, which are third party data sources that serve as bridges between smart contracts and the real world. For example, if a smart contract for the supply of goods automatically executes and transfers currency on the arrival of certain goods, the smart contract will need to be fed data confirming the delivery. A well-known issue with oracles however is how to ensure that they are trustworthy, reliable and timely - the so-called ‘oracle problem’. If an oracle cannot be trusted to provide the right information at the right time then the entire smart contract is corrupted.
- Malfunctioning code, or code not operating the way the parties intended. This may be due to bugs in the code, or to the software developers not fully understanding the intentions of the parties. On 22 April 2022, it was reported that due to a simple smart contract code error during a new NFT launch by Micah Johnson of Akutars, €34 million in ETH was locked away from both the creator and buyers. Caused by a hacker who exploited a vulnerability, and later removed the block, the funds remained irretrievable. The creator said that refunds would be made and the Aku team would push forward again with their collection.
- Legal principles, such as interpretation, offer, acceptance, consideration, intention to create legal relations, certainty, electronic signing, consumer rights, jurisdiction, conflict of law, and more.
- Blockchain risks: Read more about these in our Introduction to Blockchain publication.
The extent of the legal issues will become clearer when assessing the specific application, and how the contracts need to be customised to deal with risks.
Matheson will continue to keep a watch on developments in this space. If you would like to discuss these legal issues arising out of this publication, please get in touch with Rory O’Keeffe or your usual Matheson Technology & Innovation Group contact.