Shedding Light on Smart Contracts
With the advances in computerized transactions, smart contracts are transforming standard practices of contract laws and related business procedures. Such contracts employ computer protocols and interfaces to facilitate, verify and enforce the terms of a contract. A basic feature of smart contracts is a blockchain which keeps track of a normative set of information. The main objectives of smart contracts are to ensure that both parties involved in the contract are satisfying the conditions, minimizing all kinds of pertinent cost, such as mental and transactional costs, and making it expensive for the contractors to breach the agreement.
It is evident that smart contracts are a valuable innovation as it makes the operation of contracts efficient both in terms of cost and time. However, because of its imposing nature, smart contracts have received criticisms. Because humans don’t have the capacity to form a contract that covers every possible future state of the world, smart contracts might not be a good idea after all. In the article, “Smart Contracts Don’t Have to Be Dumb”, published by Bloomberg, the author reports how the work of Oliver Hart, one of the winners of this year’s Nobel Prize in Economics, provides an answer to the problem of incomplete contracts. Hart’s research puts forward that “Smart contracts can deal with incompleteness the same way that real-world contracts do, by allocating decision rights ahead of time.” And this also solves the problem of blockchain.
So what is the problem of a blockchain? The article “Not-so-clever Contracts,” written by Elaine Ou and published by The Economist, highlights that bugs in codes of smart contracts can lead to disastrous outcome under a completely legal framework and once the contracts have been sighed, correcting these bugs may mean a break of contract. The author writes, “A blockchain is meant to be immutable.” And this is the problem, alongside the problem of incomplete contracts, that can be solved using Hart’s research outputs.
Decision rights can be set before the contractors sign the agreement and the outcome of that can be explained by network exchange theory. Usually the person who has a higher stake in the deal will have more bargaining power. Taking the example given by Elaine Ou, let’s say there is a partnership between a student and a Tesla Model S owner. They have a deal that the owner will give the car to the student to work as an Uber driver and they will then split the money. Since the owner is the asset owner, he will have an upper hand when deciding decision rights. If in the future something happens that is not mentioned in the contract, then the agent with the pertinent decision right gets to make changes in the code and solve the problem of incomplete contract.
http://www.economist.com/news/business/21702758-time-being-least-human-judgment-still-better-bet-cold-hearted
https://www.bloomberg.com/view/articles/2016-10-21/smart-contracts-don-t-have-to-be-dumb