Breach of contract is a common problem in the business world. Recent headlines reveal many well-known names — from Disney, to Robinhood, and Elon Musk — who are facing pressure for not following through on the provisions of a contract. And those are just the well-known names. Dig a little deeper, however, and you find that breach of contract cases are reported daily, involve a wide range of industries, and can be very costly to the parties involved.
Can smart contracts put an end to breach of contract? Some experts believe they can. Understanding this emerging technology, its potential, and its limitations is important for a wide range of businesses, but also for those who engage with them.
What are smart contracts and how do they work?
“Smart contracts are e-contracts on the blockchain that execute automatically when conditions are met,” explains Jacky Goh, CEO and Co-founder of Rewards Bunny. “They work by following a simple set of rules that are written in code and executed by a network of computers after verification on the blockchain.”
Jacky is a serial entrepreneur with a long history in the crypto space and an appreciation for the potential that smart contracts hold. His company, Rewards Bunny, is the gateway to crypto rewards that rewards users when they travel or shop online.
As Jacky points out, smart contracts are executed automatically. They can be thought of as an “if/then” program, where one event automatically prompts another. For example, smart contracts can be used to facilitate the exchange of real estate. If the correct amount of funds are transferred, the smart contract then transfers ownership of the property.
Those familiar with traditional real estate contracts know that they are much more complicated than a simple “if/then” proposition. There are multiple intermediaries, including lawyers and realtors, who are intimately involved in the process. There are also a host of fees that must be paid to third parties, as well as a lot of time spent signing and certifying contracts. Smart contracts streamline the process by removing the need for third party intervention. As a result, transactions become faster and cheaper without compromising security.
How are smart contracts created?
Smart contracts rely on blockchain technology, which allows for the creation of a decentralized, immutable ledger that records the details of transactions. Traditional ledgers, like a bank account, are centralized and overseen by a third party. Blockchain ledgers allow for transactions, such as the exchange of cryptocurrency, to happen without a third-party intermediary.
“Smart contracts are created by including lines of code on a blockchain that stipulate the way a function between two parties will be performed,” explains Jacky. “Once the block with the contract is added to the blockchain, the parties involved cannot proceed with the transaction until the requirements of the contract are met.”
As the creation of blockchain assets has evolved in recent months, a host of resources have appeared online providing smart contract templates. For example, platforms that assist with minting non-fungible tokens (NFTs) often provide developers with templates for creating smart royalty contracts. When royalty contracts are programmed into the NFT, future sales cannot be finalized unless a royalty is paid to the original NFT creator.
The limitations of smart contracts
While smart contracts benefit from the transparency and security that are central to blockchain, they are not foolproof. Just like any computer program, vulnerabilities can be found and exploited by those who would seek to misuse or abuse them.
In December 2021, blockchain company MonoX Finance reported that it lost $31 million to a hacker who found a way to exploit a bug in programming of its smart contracts. Because cryptocurrency transactions depend on smart contracts for, among other things, establishing value, faulty contracts can result in huge financial losses.
The MonoX hack highlights another limitation of smart contracts: regulation and enforcement. Because cryptocurrency is not subject to regulations, victims of hacks rarely have any recourse. Once executed, a smart contract is irreversible.
“Currently, the mainstream adoption of smart contracts is limited by the lack of a strong framework for regulation and legal enforcement,” Jacky says. “Crypto smart contracts, for example, can come in different forms. Those who accept them must make sure that they come from a trustworthy source or risk their wallets getting hacked. As it stands, there is a high dependency on programmers and a high risk of exposure to bugs and vulnerabilities.”