Smart contracts: what they are, how they work, and what their legal advantages and risks are

One of the most innovative developments in the field of business is smart contracts. In this article, the international law firm Antwort Law explains what smart contracts are, how they function, what legal advantages and risks they carry, and how to effectively use this technology to automate transactions, minimizing possible legal problems.

What are smart contracts?

A smart contract is a program code that automatically executes the terms of the transaction embedded in it when certain events occur. It is based on blockchain technology, which provides decentralized data storage and immutability of records. In other words, a smart contract is a digital analogue of a regular contract, but with the ability to automatically execute and without the participation of intermediaries.

How do they work?

1. Defining the terms: the parties agree on the terms of the transaction, which are translated into program code - these can be financial transactions, transfer of property rights and other obligations.
2. Contract programming: the terms of the transaction are coded using programming languages ​​compatible with the chosen blockchain platform (e.g. Solidity for Ethereum).
3. Blockchain deployment: the smart contract is uploaded to the blockchain network, where it becomes accessible and immutable.
4. Execution: when the specified conditions are met, the smart contract automatically executes the corresponding actions without any additional intervention.

What are the economic advantages of smart contracts?

Speed ​​of execution: in international trade, payments and document verification can take weeks, but a smart contract automatically verifies the data and initiates payment, minimizing delays.

Minimization of disputes: the terms of a smart contract are written in its code, which cannot be changed, eliminating ambiguity and reducing the likelihood of conflicts between the parties. This reduces the number of conflicts, and therefore, legal costs.

Specific use cases

Financial sector: Smart contracts are used to automate lending, investment management, insurance payments, and microfinance services. For example, the AAVE platform allows for cryptocurrency loans to be issued without intermediaries.

Real estate: Using smart contracts to automatically register property ownership when purchasing real estate. For example, Propy offers blockchain-based real estate solutions.

Logistics: Simplifying supply chains by automatically verifying and paying for each stage of delivery. Maersk is implementing smart contracts to manage cargo transportation.

Insurance: Paying out insurance claims without intermediaries, such as when a flight is delayed.

Intellectual property: Automatically licensing content and collecting royalties through platforms such as Ujo Music.

How are smart contracts legally regulated?

EU: The European Union is introducing regulations for digital assets and smart contracts through the Digital Services Act and MiCA (Markets in Crypto-Assets).

US: Smart contracts are regulated by state laws, such as Vermont and Arizona, which have already adopted laws recognizing them as legally binding.

Russia: Despite the lack of clear regulation, smart contracts are considered part of digital rights under the Digital Financial Assets Act.

International law: In most jurisdictions, the recognition of smart contracts depends on compliance with local regulations.

Smart contracts are a powerful tool for automating transactions and reducing transaction costs, but their implementation requires a careful approach and consideration of legal, technical and organizational aspects. Here are our recommendations to help you successfully integrate this technology into your business:

1. Conducting legal due diligence

Before implementing a smart contract, it is important to conduct a legal review, which includes:

• Analysis of compliance with legislation: Smart contracts must comply with the legal norms of the jurisdiction where they will be used. For example, in some countries, their status may be controversial, so it is important to ensure that the use of smart contracts does not violate local laws.
• Protecting the interests of the parties: A lawyer must ensure that all key terms of the transaction are included in the smart contract, and possible controversial issues are correctly spelled out. For example, if the contract provides for penalties for violating deadlines, they must be clearly formulated.

Example: if you enter into a contract with a foreign partner, a lawyer will help integrate provisions on applicable law and the place of dispute resolution to avoid uncertainty in the event of a conflict.

2. Using hybrid solutions

Smart contracts and traditional legal contracts are not mutually exclusive instruments. In some cases, their combination gives the best result:

• Smart contract for automation: can manage the technical aspects of the deal, such as automatic transfer of funds when conditions are met.
• Traditional contract for the protection of interests: acts as a backup document that regulates aspects not covered by a smart contract, such as force majeure.

Example: in a construction project, a smart contract can automatically distribute payments to contractors as stages of work are completed, and a traditional contract will include additional conditions, such as liability for the quality of materials.

Our forecasts

The future belongs to smart contracts, which not only fulfill pre-set conditions, but are also able to adapt to changing circumstances. Example: an asset management contract can automatically change its terms based on market analysis conducted by artificial intelligence.

Also, as technology develops, countries are increasingly introducing legal regulation for smart contracts, making them a universal tool for businesses. Example: the adoption of a single legal status for smart contracts by the European Union will make it easier for businesses to operate across member states.

Smart contracts are a promising technology that can radically change the approach to concluding transactions and interactions between parties, but for their successful use it is necessary to take into account legal aspects, technical requirements and social consequences. Antwort Law is ready to provide comprehensive support in the field of smart contracts, helping clients implement advanced technologies with minimal risks.

Lidia Ivanova

International lawyer
Antwort Law