Virtually all business transactions make use of a contract in some form. Some deals are sealed with a handshake and spoken word, others require written terms and signatures. The type of contract the parties are willing to use depends on the nature of the relationship and the transaction involved.

When business is conducted between two unknown parties trust becomes a key factor. Ensuring that mutual trust exists between parties means middlemen such as lawyers are often needed to ensure a business transaction runs smoothly.

For example, when making payment for a large asset you are purchasing, the vendor’s lawyer would first confirm to your lawyer that on receiving payment they would hand the asset over, your lawyer would then pay and provide a confirmation that after making the payment, it would not be reversed. As these confirmations are legally binding between the parties, their cross over creates the trust and the transaction is completed without a hitch.

In order to remove the need (at least in part) for a third party, smart contracts utilise blockchain technology. The blockchain is a peer to peer decentralised ledger or database which has been used primarily as a way to exchange cryptocurrencies up until now. However in terms of how the blockchain works the word ‘exchange’ is slightly misleading. If I want to (generously) give you one bitcoin we request that this transaction is recorded on the peer to peer network of computers known as the blockchain. This network of thousands of computers then simultaneously records and adds to the ledger that I have one less bitcoin and you have one more bitcoin and the transaction is complete. As this ledger is recorded in a decentralised, unalterable way the system is not controlled by any one agency.

In the same way that blockchain technology can be used to exchange bitcoin it can be used to administer a set of rules. For example, a contract between two parties can be transferred to a program which automatically runs a code and at some point, if the code validates a condition and recognises that payment has been received, the code then automatically determines whether the asset should go to the purchaser or back to the vendor. While this is all happening the decentralised ledger also stores and replicates the transaction which gives it a certain security and immutability.

You might wonder what happens if the code does something shady behind the scenes? What is important to understand here, is that once a smart contract is in place it will stay there, forever, and is unchangeable. With this in mind, before you agree to participate in a transaction using a smart contract, you should insist on seeing the code that will be used, as once used it is unchangeable and will do as it is designed to. You should also take appropriate expert advice, to avoid the danger of misunderstanding what the code will actually do.

Although everyday use of smart contracts may be some way off, with companies such as Mearsk and Amazon creating their own blockchain systems it is only a matter of time before these become a usual occurrence in business transactions.

Joseph Wright

Joseph is a commercial solicitor at Steindle Williams Legal, specialising in contract and transactional matters.