Rome, 26 November 2018 - Smart Contracts expand new horizons in the manner of offering and benefiting from certain services. According to their creator Nick Szabo, Smart Contracts are “computerized transaction protocols that execute, in an efficient and transparent way, tasks pre-defined by one or more parties”.
Thanks to the development of the internet, cryptocurrencies and the Blockchain, the area of application of Smart Contracts has been increasing and it is expected to increase even more. Among early prototypes of Smart Contracts, reference is made to the traditional vending machine, providing a selected quantity of product (e.g. one coffee), against the delivery of a specified amount of money.
As the Blockchain allows parties to record their will in a permanent way, through a clear identification of the seller, the buyer and the object of the sale, the ownership of goods (digital and/or physical, if virtually represented) can be transferred in accordance with the terms of the Smart Contract; similarly, a customer may obtain an automatic refund by the airline company, in the event of flight-cancellation, or rent a car according to the terms of the Smart Contract, etc.
The Smart Contract has been defined as “smart” since it is capable of self-execution once the computerized protocol becoming the Smart Contract recognizes that the terms and conditions pre-defined by the parties have been accomplished.
The functioning of Smart Contracts is inspired by the syllogism “if this, than that”, that means in a technologic language the causal relationship between conditional statements: the Smart Contract has the purpose to provide an irrefutable result, subject to the occurrence of one or more event(s) causing the Smart Contract to perform the intended action. In light of the above, the parties to the Smart Contract entrust a “smart” software with the handling of the contractual relationship, on the tacit understanding that any interference with such a computerized protocol is waived.
Indeed, once the Smart Contract is reflected in the Blockchain (or another electronic platform, as appropriate), instructions given by the parties and consequent scheduled actions are deemed irrevocable and unchangeable. Such prerogative is a benefit but, at the same time, may restrict the use of the Smart Contract in long-lasting relationships, where parties want to keep an ex post margin of discretion which can be hardly managed by a machine.
Vice versa, it has been experienced that trades to be executed instantly can be a fertile ground for Smart Contracts, because these instruments may be helpful to reduce scepticism in online transactions and mitigate the risk of frauds over the internet. Those who decide to take advantage of Smart Contracts can rely on the fact that, once launched in the Blockchain, the Smart Contract will be capable of self-execution, upon satisfaction of predefined conditions on a certain date and time. For instance, since the performance of A (seller) is conditioned upon and, at the same time, undividable from the performance of B (buyer), ideally the accomplishment of the transaction managed by the Smart Contract will be simultaneous. As a consequence, A (seller) will be prevented from collecting the price, if the promised good is not transferred, whereas B (buyer) will be prevented from cancelling the payment, once the transfer has been executed (so-called chargeback frauds).
The scope is to establish a certain legal relationship with an undisputable effect, which the parties are willing to pursue (in the example above: transfer of goods vs payment of price). Any potential objection is postponed after the execution, so that a party may seek an indemnification if something goes wrong, but the objection will not suspend the Smart Contract and the effects linked to it.
This approach is not new in the Italian legal framework, being a peculiar application of the principle set forth in article 1462 of the Italian Civil Code, pursuant to which parties are free to strengthen their commitment by waiving objections to avoid and/or delay the relevant performance.
The legal issue implied by the use of Smart Contracts is to put a limit to the freedom of parties to plan whatever they want. Effects planned in Smart Contracts should be impeded, if conflicting with public order and/or general interests protected by mandatary laws and/or in the same cases of nullity, rescission and annulment regulated by the abovementioned article 1462.
The evolution of technology will ideally be a valid support to ensure a proper governance of Smart Contracts, permitting external corrective actions should the “smart” protocol result to be illegal or unfair.
Equally important is to correct Smart Contracts in case of mistakes, or subsequent adjustments due to unexpected situations, also through self-protection remedies provided for by the law (including but not limited to the right of one party to suspend his/her performance, if the other party is not performing, as per article 1460 of the Italian Civil Code).
In the situations above depicted, courts should be entitled to check whether the purpose targeted by the Smart Contract is legal and, if not, proper measures should be adopted to restore fairness and legality.
From an operative point of view, the actual use of Smart Contracts requires technical and digital capabilities of the users, to translate the human language in “smart” terms understandable and supportable by the Blockchain, or by other web platforms.
Therefore the use of Smart Contracts will depend on the amount of financial resources that investors are willing to spend, considering that the more standard are the terms of Smart Contracts and massive their implementation, the greater should be the potential turnover of those prepared to gamble on this technological frontier.
To see our glossary 'PeA FinTech Syllabus': https://www.pavia-ansaldo.it/fintech-syllabus/?lang=en
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