Contracts are the backbone of an enterprise. Blockchain technology will have important implications when it comes to contract management. Blockchain is becoming a new area of interest, for governments creating secure databases of land titles to consortiums of leading financial institutions working together, to design new distributed ledger technologies.
Contract management helps the contracts that are self-enforcing or self-executing. The Blockchain’s role in the contract is to replace a third party required to resolve a legal dispute. Known as “smart properties” or “coloured coins,” a token could be used to represent any asset, from stocks to cars. The ability to hard-code transfer of ownership when trading these assets can potentially create “unbreakable” contracts.
For instance, a red-widget factory receives an order from a new customer to produce 100 new type of blue widget. This requires the factory to invest in a new machine. They will only recoup this investment if the customer follows through on their order.
Instead of trusting the customer or hiring an expensive lawyer, the company could create a smart property with a self-executing contract. Such a contract might look like this: For every blue widget delivered, transfer price per item from the customer’s bank account to the factory’s bank account. This eliminates the need for a deposit or escrow (which places trust in a third party). Also, the customer is protected from the factory under-delivering.
Although this remains mostly theory, platforms like Ethereum are bringing smart contracts closer to reality.
How does it work?
“Smart contract” here refers to a specific use case of smart-contract code. It is a way of using blockchain technology to complement or replace, existing legal contracts. This is the definition of the term I considered in the use of code to articulate, verify, and enforce an agreement between parties.
These smart legal contracts would most likely be a combination of smart contract code and more traditional legal language. For instance, imagine a supplier of goods enters into a smart legal contract with a retailer. The payment terms could be defined in code and executed. But the retailer would likely insist the contract, whereby the supplier agrees to indemnify the retailer against claims flowing from a defective product. There would be no point representing this clause in code since it is not something that can self-execute – it exists to be interpreted and enforced by a court in the case of litigation.