Smart Contracts: What Are They and What Do They Mean for International Trade?
Editor’s Note: The below article is the last in a three-part series about blockchain and its implications on international trade. Read the first and second articles here.
By Sammy Naji
Of all the blockchain-based innovations, smart contracts running off blockchain may be the most transformative for international trade. Smart contracts will go beyond eliminating the reliance on physical paper in international transactions by potentially removing the need for financial intermediaries altogether. Smart contracts can be described as self-executing contracts that run off code, which initiate performance and automatically impose penalties when predefined conditions are met.[1] They essentially serve as automated escrow robots.[2]
Smart contracts can be revolutionary as there can now be a trade system where letters of credit issued by banks are potentially no longer needed. Smart contracts can substitute for the trust that banks traditionally provide, as smart contracts can help a seller be assured that payment will be received upon performance and a buyer that payment will not go to the seller when the seller does not perform.[3] Smart contracts also have the potential to get rid of the inequities of the current letter of credit system, which requires the bank to pay the seller as long as the seller submits the requisite documents instead of when performance is completed.[4]
Smart contracts running on blockchain technology in international trade can dramatically reduce fraud and increase transparency throughout a supply chain as the system’s sensors can emit real-time and unalterable information regarding the condition of goods.[5] Sensors can also keep track of where the goods are in the chain and whether the goods have sustained any damage.[6] Smart contracts can trigger payment to a seller when a shipment is successfully completed or induce payment to be returned if certain conditions such as the temperature of a container do not meet contract specifications.[7]
The trust and automation that smart contracts can form also has the potential to decrease the need for centralized international business relationships.[8] The current incentives for engaging in foreign direct investment (“FDI”) and close subsidiary engagements include the inability to trust that a foreign entity will comply with agreements when the foreign entity is located far away in a country with a different court system.[9] Smart contracts remove many of these incentives, as they minimize the risk of breach and render enforcement automatic.[10] Furthermore, blockchain’s transparency can decrease the incentives for trading parties to engage in contractual breaches because a party’s actions can be available for all to see on the blockchain.[11]
Though smart contracts are posed to provide increased efficiency to international trade, there remains substantial uncertainty about their legal implications. Eliminating the human element from contract enforcement, for example, can lead to situations where smart contracts can be exploited through loopholes in the code.[12] This was the case in the most well-known attempt to create a decentralized international entity, where over fifty-million dollars were stolen through a backdoor in the smart contract code that the entity was organized on.[13] Moreover, the anonymity and lack of formalized structure that such entities pose creates difficult questions for the enforcement of legal accountability. Finally, the decreased reliance on human third parties and increased reliance on self-executing smart contracts for the transfer of physical items may result in sellers who find ways to bypass the sensors, placing the buyer in a situation where litigation is still necessary to receive contractual damages.[14] Despite these uncertainties, however, the ability of smart contracts to bring much overdue improvements in lowering fraud, costs, and inefficiencies make their application to international trade an exciting prospect.[15]
Sammy Naji is a third-year law student at Campbell University School of Law interested in practicing corporate and international trade law. Sammy can be reached via email at [email protected]. You can also find him on LinkedIn at www.linkedin.com/in/sammy-naji.
[1] See Yang Chu, Getting Smart About Smart Contracts, WALL STREET JOURNAL (July 8, 2016), http://deloitte.wsj.com/riskandcompliance/2016/07/08/getting-smart- about-smart- contracts.
[2] See id.
[3] See id.
[4] See Ross P. Buckley, The Development of the Fraud Rule in Letter of Credit Law: The Journey So Far and the Road Ahead, 23 J. Int’l L. 663, 678 (2002) (citing S tzejn v. J. Henry Schroder Banking Co., 31 N.Y.S.2d 631 (Sup. Ct. 1941).
[5] See Chris Skinner , Five Standout Startups Focused On Blockchain Trade Finance, THE FINANSER , http://thefinanser.com/2016/08/fivestandout-start-ups-focused-upon-blockchain-trade-finance.html.
[6] See id.
[7] See id.
[8] Don Tapscott, Blockchain Revolution 99-111 (2016)
[9] Daniel C.K. Chow, International Business Transactions: Problems, Cases, and Materials 284 (3d ed. 2015).
[10] See id.
[11] See id.
[12] See Michael D. Castillo, The DAO Hacker is Getting Away, COINDESK.COM (August 8, 2016), http://www.coindesk.com/ethereum-dao-hacker-getting-away-classic.
[13] See id.
[14] See id.
[15] See id.