The Use of Smart Contracts for Legally Binding Agreements
Smart contracts are used across blockchain and cryptocurrency projects to facilitate software development and other online transactions. They may also soon be an option for legal agreements, potentially lowering the costs incurred from using lawyers and other intermediaries.
Updated January 20, 2021 • 3 min read
Smart contracts are used across blockchain and cryptocurrency projects to facilitate software development and other types of online transactions. They may also soon be an option for parties to legal agreements in real estate or for corporate structures, potentially lowering the costs incurred from using lawyers and other intermediaries. However, using smart contracts before regulations are in place and legal precedents set remains risky.
Legal Considerations and Contracts
Technology has been driving innovation in the legal industry, most recently with the advent of e-signatures for binding legal agreements. Perhaps the newest innovation in this space is the emergence of smart contracts, which can code certain types of legal agreements onto blockchains. The widespread use of smart contracts for particular types of transactions, which can lower costs and increase transaction speed, is closer than you may think. Nevertheless, their use does present some challenges and potential pitfalls.
Some U.S. states are beginning to permit the use of smart contracts in certain contexts. For example, Arizona allows enforceable legal agreements to be created via smart contracts, and California allows marriage licenses to be issued via blockchain technology.
Most lawyers, however, are not coders and therefore are unlikely to have the technical aptitude to build a smart contact. Coders who can build smart contracts (and are not themselves lawyers) are likely unaware of all the legal considerations required for drafting strong, reliable contracts. In order to move toward more widespread adoption among legal professionals, legally enforceable smart contract templates for common legal agreements need to be developed by learned professionals. The creation of standard templates for certain types of transactions may make smart contracts a tool that any lawyer (or even a non-lawyer) can use.
In the meantime, if you choose to use a smart contract, do so cautiously and ensure the smart contract is reviewed by an attorney prior to issuance. Below are a couple of notable use cases that could lead the way in smart contract adoptions.
There have been a few experiments in tokenizing real estate transactions and should that practice become more widespread, it could make up a meaningful portion of the multi-trillion dollar real estate market. Anyone who has ever purchased a home or other property, will be aware of the hidden costs connected to closing fees, title transfers, broker fees and more.
Beyond the execution of contracts in a real estate transaction, smart contracts could benefit parties by streamlining rental agreements, complex credit or mortgage agreements as well as warranties and insurance. By using smart contracts to execute these agreements, the need for legal counsel or other advisory services becomes less crucial, saving on costs across the board.
When a piece of property is tokenized, much of the required record keeping can be stored within the token via smart contracts, which will save the parties time and money. This can save both the buyer and seller tens, if not hundreds of thousands of dollars. Again, it is critical to make sure that any smart contracts are enforceable in the state the transaction takes place and that the smart contract is written to avoid vulnerabilities that could crop up.
In 2017, Delaware passed Senate Bill 69 allowing businesses to be incorporated and managed using blockchain technology. This bill opened the door to the proliferation of Decentralized Autonomous Organizations (DAOs). Although there have been some false starts, many believe that corporations where ownership and compensation can be built into smart contracts could lead to increased global collaboration and innovation.
Although Bitcoin is not a corporation, those who manage the network are compensated based on a set of rules built into the protocol. DAOs, using smart contracts to encode corporate structures, can enable similar incentive structures within a corporate framework. DAOs can also drive savings in administrative costs including office space, hiring and payroll through incentive structures that may not include formal employment contracts.
Unlike Bitcoin, which builds inertia based on community and macroeconomic events, smart contracts will only likely gain mass adoption once entrepreneurs build products that make it just as easy to use a smart contract as it is to hire a lawyer.
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