What Are Smart Contracts?
The fact that you did not have to go to the bank to sign a contract with a pen, but instead received the contract by email in PDF format and signed it electronically using a qualified electronic certificate, thereby entering into a contractual relationship with the bank, does not make that contract a “smart contract.” This contract is, in essence, still a traditional agreement between two parties. The only difference lies in the method of signing and the fact that the contract was concluded electronically, i.e. in electronic form.
Smart contracts should also be distinguished from contracts concluded through computers and electronic commerce platforms (e-contracts), which are legal transactions entered into electronically between service providers and users. The use of technology in this context enables e-contracts to be concluded more quickly and easily by means of a qualified electronic signature, which allows contracts to be concluded remotely and accelerates the contracting process while providing a high level of security for both parties.
On the other hand, smart contracts differ from standard forms of contracts in that they exist in digital form. They can be most simply defined as computer programs stored on a blockchain that execute automatically once the specific conditions set out in the contract have been fulfilled. Smart contracts differ from the electronic contracts referred to above, which are written in natural human language, in that they are written in computer code.
The term “smart contract” is precisely defined in the Digital Assets Act (“Official Gazette of the Republic of Serbia”, No. 153/2020), in Article 2, paragraph 1, item 39:
“A smart contract is a computer program or protocol based on distributed ledger technology or similar technologies that, in whole or in part, automatically executes, controls, or documents legally relevant events and actions in accordance with a previously concluded contract, whereby such contract may be concluded electronically through such program or protocol.”
The definition of a smart contract itself contains a certain contradiction, as it suggests that a smart contract is, in fact, not a contract but rather a computer program whose primary function is to automatically execute predefined contractual clauses once the specified conditions have been fulfilled, in accordance with an already concluded agreement.
Smart Contracts and Their Automatic Execution
It is important to distinguish between the two separate agreements referred to in the definition provided by the Digital Assets Act. Namely, the creation of a smart contract is preceded by a written or oral agreement concerning the terms and conditions of performance. The smart contract itself, however, is a computer program or protocol in which the performance of that agreement is entrusted to computer code deployed on a blockchain network, ensuring that the agreement will be executed in accordance with the terms agreed upon in advance.
Smart Contracts and Cryptocurrencies
Smart contracts have played a key role in the development of decentralized applications based on cryptocurrencies, but their application is now expanding into other areas as well, including insurance, supply chains, and banking. The cryptocurrency market has long been a major driver of technological innovation, and smart contracts, as an emerging technology, were introduced in 2014 as part of the specification for the Ethereum cryptocurrency. All decentralized finance (DeFi) applications built on blockchain technology are fundamentally based on smart contracts.
From a legal perspective, smart contracts were defined as early as 1994 by American computer scientist, legal scholar, and cryptographer Nick Szabo. However, as can be seen, it took nearly two decades for the underlying technology to develop sufficiently to enable the practical implementation of smart contracts.
What Are the Characteristics of Smart Contracts?
Digital Form – written in computer code;
Decentralization and Transparency – the contract operates on a decentralized blockchain, with no single entity acting as the custodian of the data. It functions independently of third parties and the contracting parties themselves, is accessible to everyone, and allows all participants to view the code and all transactions.
Immutability – once the code has been deployed, it cannot be unilaterally modified;
Self-Execution – automatic enforcement of the rights and obligations of the contracting parties without human intervention; the contract is executed automatically, and the code performs exactly what it has been programmed to do, without any discretionary interpretation.
Application of Smart Contracts in Various Areas of Law
For example, a clausula intabulandi in a real estate sale and purchase agreement could be structured as a clause that is automatically triggered once the purchase price for the property has been transferred to the seller’s bank account. Upon receiving confirmation that the payment has been made, the smart contract would automatically submit a request to the land registry for the registration of the buyer’s ownership rights. The agreement would therefore be executed automatically, without the need for any additional declaration by the seller. The process would not depend on the working hours of notaries public or banks, and the smart contract would provide assurance that, almost immediately after the buyer transfers the purchase price to the seller, the buyer will also be registered as the owner of the property in the land registry.
Challenges of Implementing Smart Contracts in Practice
A programmer would certainly argue that it is not impossible to create a computer program that would automatically execute a contract in this manner. However, this is where legal practitioners would explain that the matter is far more complex. In order for such a system to be implemented in practice, at least three laws would need to be amended to establish a legal framework that would allow real estate transactions and the registration of ownership rights in the land registry to be carried out through a smart contract structured in this way. As long as certain contracts are subject to specific formal requirements, such as notarization by a public notary or other prescribed formalities, the practical application of smart contracts remains largely within the realm of legal theory.
Smart contracts have been in use for barely a decade and are still at an early stage of development. Numerous shortcomings have also emerged in the implementation of smart contracts in public blockchain transactions, particularly during the early development of the cryptocurrency market, when it came to ensuring the security of cryptocurrency transactions. There were instances of hacking attacks in which millions of dollars’ worth of cryptocurrency were stolen. Consequently, significant efforts have been made over the past decade to improve the resilience of these systems and strengthen the protection of all participants in decentralized cryptocurrency markets.
The Future of Smart Contracts in Serbia
Smart contracts must first be accepted by the relevant institutions, which will establish a legal framework for their implementation, and ultimately by legal practice.
The fact that smart contracts are defined under the Digital Assets Act is a step forward towards their wider adoption, but practice will ultimately show the true scope of their application.
