Blockchain and Smart Contracts: Where is the potential?

Blockchain and smart contracts are buzzwords that are being encountered more and more frequently and are associated with great expectations. There is talk of changes like those that followed the introduction of the Internet, just as there is talk of the end of conventional contracts, which in the future will only be concluded quickly and digitally in the form of a program code. But what is behind these two terms and how are they connected? And are such lofty hopes at all justified? This article aims to clarify these questions and shows what is already possible, both practically and legally.

Blockchain: a good option for legal matters?

First the basics: Blockchain technology gained notoriety in the wake of the Bitcoin hype, which is why it is still often associated only with cryptocurrencies. However, the technology has long since taken on a life of its own and its special properties can be used for a wide variety of use cases.

Put simply, the blockchain is a network to which numerous participants have access. The participants themselves represent redundant nodes in the network, minimizing the risk of manipulation. On the network, information (usually transactions) is stored in blocks. As soon as a block is full, the next block is used, gradually creating a chain, the blockchain. This results in a digital, decentralized register. This not only makes it possible to view the status of the information stored in the blocks, but also to track the entire development from the beginning. Importantly, the information is encrypted and a hash value, a checksum of the stored data, is formed. The hash value of one relates to that of the previous block. This reduces the risk of manipulation to a minimum: as soon as a value is changed, the entire chain no longer fits together, and the change becomes obvious. A not unimportant side effect: since one, for example a bank, is no longer needed, (transaction) costs are largely eliminated.

A blockchain is therefore ideal for proof and documentation purposes. The authenticity of documents and information of all kinds can be quickly verified, and at any time it is possible to prove who had access to the information at what time. In China, blockchain has even been admitted as evidence in court, and similar efforts are evident in many other countries. In the EU, for example, the eIDAS Regulation stipulates the judicial recognition of electronic time stamps that can be used to link the storage of data on a blockchain to a point in time.

Smart contract: more than a contract?

At the same time, blockchain technology has increased the importance of smart contracts, whose potential can be fully exploited with it. Smart contracts are neither contracts in the classic sense nor intelligent in themselves, but basically computer programs that – when certain events occur – implement pre-programmed processes, such as transferring money or activating access. To do this, the conditions for and the consequences of events are formulated and written into a program.

Users should note: This is not a contract in the legal sense. In many cases, smart contracts cannot fulfill the necessary requirements, for example, if a handwritten signature is needed to make a contract effective. In practice, therefore, the model of first concluding a conventional contract, based on which a smart contract is programmed, which then quickly and independently implements what was previously agreed in the contract, is probably recommended. Although smart contracts cannot yet easily perform complex legal evaluations, clear if-then relationships can be implemented quickly, cost-effectively, and securely. Many conceivable contractual relationships in which processes are to be automated are suitable for this. Typical examples are the activation of a license with the payment of the license fee or the immediate compensation payment in case of a train or plane delay. Other applications lend themselves to the Internet of Things (IoT) sector. A smart contract can directly initiate payment during the charging process of an electric car or, for a 3D printer, initiate the printing process as soon as permission has been verified.

Smart Contract and Blockchain: A Good Connection

While smart contracts do not necessarily have to run on a blockchain, the advantages of the blockchain for smart contracts are obvious. Unlike traditional contracts, the blockchain’s high tamper-resistance increases the parties’ trust. It can also avoid unwanted litigation by clearly and unambiguously defining the terms before the smart contract is launched and then executing them automatically and mandatorily. The smart contract even replaces arbitration boards. This clarity significantly reduces the potential for disputes, although this effect only materializes if the terms of the smart contract have been cleanly and fully legally reviewed in advance and it is in accordance with the will of the parties and the relevant laws. The possibility of digital signatures instead of handwritten signatures (if such a form is not prescribed) and automatic payment makes contract execution via smart contract cost-effective, practical and thus more attractive for customers than conventional contracts.

The end of classic contractual relationships?

Why do we need a paper contract at all, you might ask? But despite all the euphoria, ideas that blockchain and smart contracts will completely replace large parts of the judicial system or traditional contractual relationships are unlikely to become reality any time soon. It is also questionable whether this must happen at all. After all, contracts are nothing more than recorded declarations of intent by the contracting parties. Even in digital times, parties will not want to conclude contracts without declarations of intent, which is why these requirements will continue to be valid and smart contracts can be easily integrated into the existing legal system.

However, despite high security and efficiency, using a blockchain is not without its challenges. The rapidly growing amount of data that needs to be stored on all participating computers requires a great deal of technical effort, so blockchain applications also have limits and it remains to be seen how the capacity issue will play out in the future. And some questions also arise from a legal perspective. As already indicated, in practice one should limit oneself to what is already technically feasible and not leave complex legal issues such as trade-offs or the filling in of undefined legal terms to a smart contract. The issues to be clarified also include data protection aspects. Anyone who runs the activities of a smart contract via a blockchain and relies on consent in terms of data protection law must bear in mind that the entries on the blockchain cannot be deleted without further ado and that problems therefore arise with the requirement that consent must be revocable. The same applies to the right to be forgotten under the GDPR. One possible solution may therefore be to resort to a legal basis other than consent. Anyone who wants to use smart contracts should therefore rely on a well-thought-out combination of technical expertise and legal safeguards. With the right approach, a wide range of contractual relationships, the organization of IP rights, and many other applications can be taken to a new level.

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