According to Nick Szabo, a smart contract is “a set of promises, specified in digital form, including protocols within which the parties perform on these promises.” There are many more examples of smart contracts, with varying levels of sophistication: from simple crowdfunding platforms to more complex integration with blockchain and cryptocurrency. To simplify things, the example of a vending machine is useful to illustrate a machine that is programmed with a seller’s offer and executes the terms of an agreement (e.g. dispense a candy bar) automatically once the conditions (e.g. insert one dollar) are met. What is relevant here is that the automatic nature of the contract removes the need for humans. A smart contract is a program or a set of instructions that automatically perform a task according to the terms of an agreement.
Now let’s imagine a world without vending machines. I see your candy bar and I offer you one dollar in exchange for it. You accept my offer, then I hand over my dollar and you hand over your candy bar. Transaction complete: everybody is happy and maybe I made a new friend – why would we ever need smart contracts? Well, not everybody is so friendly, and misunderstandings happen all the time. That is where we need contract law and the courts. Or, in the words of philosopher Thomas Hobbes, “Covenants, without the sword, are but words…” Luckily, the sword we all have is the legal system; unfortunately, there’s a very long line to use this sword and it is expensive to swing it.
This is where smart contracts might have an advantage. Let’s imagine that I hand over my dollar, but instead of handing over your candy bar, you run away with my money. Now I have to go to court and ask for a remedy because you breached our contract. At the end of the day, I still might not get the chocolate bar. I am better off dealing with the vending machine.
Contracts can be thought of as a legally enforceable promise, but smart contracts are different from the typical contract in law (see Kevin Werbach and Nicolas Cornell for an excellent analysis on this topic). One peculiar divergence with smart contracts is that a breach is, in principle, impossible. At this point, the vending machine example can be confusing – vending machines break and often fail to dispense the candy bar because of some mechanical issue. Let’s now think a bit more abstractly about computer programs and code. A basic conditional statement for my morning alarm might look like this: “IF the time is 7 AM, THEN play the alarm, ELSE do nothing.” Now imagine that I promise to give you $1 if you give me a wakeup call tomorrow at 7 AM, or else, if you fail, I keep my $1. I can make this into a smart contract by locking away $1 (perhaps using cryptocurrency to suspend it on a blockchain) and programming something like this: “IF you call at 7 AM tomorrow, THEN transfer to you $1, ELSE transfer to me $1.” Notice how neither of us can go back on our deal; it’s out of our hands, it’s impossible to change (see Max Raskin for further discussions on the legality of smart contracts).
The interesting upshot is that by making breach impossible, it eliminates the possibility of breaking the promise. Legal scholars debate the relationship between contracts and promissory morality. Some argue that contract law should be understood in economic terms, while others argue that contract law should make more space for promissory morality or consistent with a rights-based morality. However, in making breach impossible, smart contracts seem to sterilize the relational aspects of trust and shared projects, which seem vital to the institution of contracts in general.
I remember reading Evans v. Teamsters Local Union No. 31 in my 1L contracts class for mitigation. In short, it’s about an employee in a dispute with their employer over a layoff and – despite the bad blood between employee and employer – the court concluded that the employee should have taken the employer’s subsequent offer of re-employment to mitigate damages. The Court seems to expect us to put our emotions aside. But people are not rational maximizers or cold automatons. Smart contracts seem like a step in this direction. While smart contracts are certainly more efficient and perhaps more reliable, their inflexibility may limit litigants to restitutionary remedies and pose further doctrinal challenges for accountability and fairness.
Written by Dan Choi, a second year JD Candidate at Osgoode Hall Law School and an IPilogue Contributing Editor.
