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Smart contracts are manifestations of blockchain – an application which functions and is developed within the infrastructure of blockchains.

Thus, we shall start by saying that it is a technical creation, and not a legal one, which is built upon a computer concept. In fact, Nick Szabo was probably the first in defining them, more than 25 years ago, as a set of promises specified in digital form, which includes protocols within which the parties to the contract act in accordance with said promises. The essence of smart contracts lies in their self-executing nature, in such a way that “if something specific occurs, consequences shall arise”, and this process transpires outside of the direct will of the parties, albeit in a mediate manner the parties have agreed upon a computer programme, which we shall call a “codified agreement”. The structure of the smart contract is based upon computer language, which allows it to act and come into effect with autonomy and automation, although always within a codified framework. Hence, the term “smart” is questionable, given that intelligence (whether natural or artificial) allows adaptation to the environment or circumstances given at any time, even when they are unforeseen, whereas the smart contract lacks this flexibility as it is unable to modify neither its structure nor its premises, and therefore its end result, although the circumstances surrounding the contract may have changed and they may make it unenforceable or cause an injustice according to the rules of law.

If the basis of the smart contract is a more or less complex set of computer lines, a sequence of premises, instructions and consequences which act in an automated way and without taking into account any context, we cannot consider it to be a contract in the legal sense.  Contracts are based upon the will of the parties, which may vary during the course of the validity thereof, and considering that the circumstances may bring about their invalidity or modification; conversely, the smart contract acts without neither conscience or consideration for the setting. In spite of this, we may contextualise their limited existence and reach by considering them as a part of legal contracts, conceiving smart contracts to be computer-related parts that allow for the automated fulfilment or execution of certain consequences, based upon the premises agreed upon by the parties of the legal contract. As an example, we may consider a purchase and sale contract in instalments wherein the premise is the arrival of a certain date and the consequence is the bank transfer or the charge to the account of the amount agreed upon for each instalment. In this hybrid mode, the smart contract or codified agreement does not have a life of its own, but it does act as an element of a legal contract assuming functions of execution freely agreed upon by the parties, although at the same time  they are subordinated to said legal contract.

The recognition of the smart contract requires the confidence shown by the parties and that of the legal system in blockchain technology, and this recognition is reached by verifying the trustworthiness of the programme which supports it and its suitability to the legal environment. If recognition is given to blockchain technology, the smart contract has the advantage that its enforceability does not depend upon the intervention of a third party, a mediator or a certifying public officer who determines the fulfilment of the premise which gives rise to the emergence of a consequence, since the programme itself determines it and the chain of nodes validates the operation, and once executed, it no longer admits neither cancellation or further manipulation. Sillaber y Waltl explain that the smart contract has four life-cycles: creation, establishment, execution and finalisation. The programming and validation thereof correspond to the second phase, and perhaps the most important phase, because once establishment has been completed by way of the reading and intervention of an indeterminate number of nodes, the contract becomes  “established” and it shall be automatically self-executed when the premises which have been validated in this phase are realised. Taking this into account, and because validation from a centralised authority or an intermediary are not necessary, it allows for very rapid and flexible technical solutions, and at the same time financial savings which may be employed in the current business model. On the other side of the coin, we encounter the dangers of automation: for example, a contract may provide for the execution of a financial guarantee in the event of non-payment on a given date, but if that event is caused by the effects of a third party or an unpredictable variable not provided for in the programme, the contract will still be executed and the amount pledged as guarantee will end up in the hands of the executing party.  The reversal of this consequence may be difficult, and at the very least, slow and costly.

Although we may say that smart contracts avoid queries and interpretive grey zones inherent to legal contracts articulated with traditional language, the former lack the necessary flexibility to avoid a consequence which is unjust or contrary to the real will of the parties. The principles associated with contracting such as contractual good faith or the abuse of rights are not taken into account in computer language, so that such a contract may in itself be contrary to the law, even if their computer programming lines provide for consequences entirely in accordance with the will of the parties involved.  We could say that the smart contract generates a “fatal” result, the fulfilment of what has been programmed together with a premeditated ignorance of the circumstances surrounding the contract may be dangerous. In order to prevent the “blind” execution of smart contracts, some authors point to the possibility of activating their execution by mutual agreement between the parties by means of a protocol of multiple and crossed signatures, but this measure would take away one of their principle characteristics and possibly virtues: self-execution.

The solution to this problem must be sought in the very design of the programme because the nature of smart contracts is substantially technical. It is a matter of incorporating computer solutions, which allow the distinction between when a contract may be freely executed and when this is not possible, based not only on a mere binary formulation of “YES/NO” in order to arrive at a conclusion, but instead the activation of more complex transversal aspects relative to an smart contract setting, whose use will come from artificial intelligence technology.
At the same time, in order to achieve a progressive integration of the technical proposal of the smart contract into the legal environment in which it will be developed, its preparation should be carried out with the joint cooperation of computer and legal specialists.

For further information, please contact:

Eduardo Vilá

va@vila.es

1st March 2019

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