Smart Contracts

A smart contract is a computer protocol that can electronically enable the negotiation or performance of a contract. These types of contracts facilitate transactions without third-party intermediaries and are usually traceable and nonreversible. In short, they work on an “if-then” principle that requires the occurrence of a preceding event. It includes three main components: (1) signatories/parties; (2) subject/substance; and (3) terms/conditions. The smart contract supporters suggest that contractual provisions can be self-executing and/or self-enforcing. In fact, some forms of digital currencies have applied and used smart contract frameworks.

Smart contracts are computer programs that can be used in a blockchain or distributed ledger. The blockchain or distributed ledger automatically keeps track of digital currency transactions without third-party control or supervision. Smart contracts use a self-executing procedure that is automatically enforced without interference or manipulation. For example, Bitcoin, Ethereum, and Ripple use smart contract frameworks. However, there are security issues with using this technology since blockchain-based smart contracts are visible to other users.

Smart contracts can be used in real estate transactions and escrow services which manage the exchange of real property and control the transfer of the funds. For example, the escrow company transfers the funds from the buyer to the seller after the real estate transaction is fully consummated by the parties.

Smart contracts can be also used by the financial institutions that rely on electronic funds transfer as a mechanism for ordering, instructing, or authorizing a financial institution to debit or credit a consumer’s account. See the Electronic Fund Transfer Act for more information. Now, many public and private financial institutions have accepted cryptocurrencies which use smart contract frameworks.

However, with every new concept, there could be complications especially when it’s an emerging technology. So, it must be perfected to the point that it’s devoid of bugs since the technical weaknesses can be exploited by the culprits. For example, a known software bug can be used by hackers to steal money. Is it possible to legally rescind the contracts for any reason? Or, will the computer program mandate its completion without exceptions? Also, will the government regulate and tax the smart contracts?

What are the legal issues or implications?

We can confidently say that there will be legal issues and implications with smart contracts. Therefore, state and federal laws should be promulgated to protect the interested parties. In addition, there is always a potential of fraud or embezzlement when it comes to financial transactions. In California, fraud is defined as an intentional misrepresentation, deceit, or concealment of a material fact known to the defendant with the intention of depriving another person of his or her property rights. Embezzlement is the fraudulent appropriation of property by a person to whom it has been intrusted.

In California, the Uniform Electronic Transactions Act specifies that a record or signature may not be denied legal effect or enforceability solely because it is in electronic form and that a contract may not be denied legal effect or enforceability solely because an electronic record was used in its formation. This statute provides that if a law requires a record to be in writing, or if a law requires a signature, an electronic record or signature satisfies the law. See also AB 2658 for more information.

In Arizona, the law defines “blockchain technology” as distributed ledger technology that uses a distributed, decentralized, shared and replicated ledger, which may be public or private, permissioned or permissionless, or driven by tokenized crypto-economics or tokenless.

It's important to know your legal rights and responsibilities when it comes to smart contracts. Please contact our law firm to speak with a knowledgeable business attorney at your convenience.