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Do smart contracts herald the end of administrative red tape?
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Research

Do smart contracts herald the end of administrative red tape?

Smart contracts can turn our ways of doing business on their head.

7 minutes
01 March 2021

Transparent, cheap, safe, and fast. Smart contracts can completely transform our ways of doing business. Researchers at KU Leuven Campus Brussels predict a bright future for smart contracts that use blockchain technology.

Whether you are ordering pizza, booking a holiday, or renting a house: trust is a cornerstone of every economic transaction. Buyers want value for money and sellers want the right price for their products. The more important the transaction, the greater the need for trust. That is why we use notaries when buying a house, for example. Such middlemen may guarantee the correct compliance with a contract, but they also cost a lot of money, slow the process down, and sometimes make mistakes. Smart people are therefore experimenting with so-called smart contracts, which limit human interventions to a minimum.

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Vending machine

The name smart contract is somewhat misleading. The word ‘smart’ may lead one to suspect that artificial intelligence is involved, suggesting in turn that smart contracts learn from one another, a little like self-driving cars. That assumption is incorrect. The term ‘contract’ does not completely cover the content either. A smart contract is actually a software programme that conducts a certain transaction automatically as soon as certain conditions are met.

Frank Hoogendijk at the Jan Ronse Institute for Company and Financial Law compares the principle of the smart contract to that of a vending machine. “You throw in a coin, select a drink, and the beverage of your choice automatically drops out of the machine. The logic of smart contracts is identical: one step follows from the other, according to the ‘if-this-then-that’ principle.” A contract is a lot like a step-by-step plan: there is first a quote, then an order, then a delivery, and finally the payment … Each event leads to the next step, so you can initiate a chain reaction.

Smart contracts build on so-called blockchain technology. Does that name ring a bell? If it does, it is probably because this is the mechanism behind Bitcoin, the virtual currency that is causing a furore. Blockchain technology is very complicated. The ingenious thing about it is that information (concerning a transaction, for example), is no longer stored on one central server, but in a network of different computers or nodes. These nodes each contain a copy of the ledger in which data is logged. Without the intervention of a central party, nodes can reach consensus about the logged data and conduct transactions. The data is recorded in blocks, which form a chronological and unchangeable chain. Hence the name blockchain.

This decentralization offers many advantages. For example, it is almost impossible to change the data, precisely because so many users monitor everything. In principle, every participant can see and check all the transactions. In other words, blockchain generates trust. And thanks to that trust, you no longer have to pay (expensive) independent parties to monitor correct compliance with the contract.

Whether you think it is a good thing or not, nobody can deny that Bitcoin is shaking things up.

Smart contracts build on so-called blockchain technology. Does that name ring a bell? If it does, it is probably because this is the mechanism behind Bitcoin, the virtual currency that is causing a furore. Blockchain technology is very complicated. The ingenious thing about it is that information (concerning a transaction, for example), is no longer stored on one central server, but in a network of different computers or nodes. These nodes each contain a copy of the ledger in which data is logged. Without the intervention of a central party, nodes can reach consensus about the logged data and conduct transactions. The data is recorded in blocks, which form a chronological and unchangeable chain. Hence the name blockchain.

This decentralization offers many advantages. For example, it is almost impossible to change the data, precisely because so many users monitor everything. In principle, every participant can see and check all the transactions. In other words, blockchain generates trust. And thanks to that trust, you no longer have to pay (expensive) independent parties to monitor correct compliance with the contract.

Smart contracts in brief

  • Smart contracts are agreements that are implemented automatically
  • The conditions that the purchaser and seller agree to are coded
  • This occurs through the use of blockchain technology
  • Information is shared and stored in a decentral network
  • This transparency creates trust and prevents fraud

No fuss

The fact that blockchain can be disruptive has already been demonstrated abundantly by Bitcoin, Niels Vandezande of the Research Unit KU Leuven Centre for IT & IP Law. “Whether you think it is a good thing or not, nobody can deny that Bitcoin is shaking things up. It perfectly illustrates what blockchain technology is capable of. People are currently looking for other interesting applications for blockchain. But it is very clear that they exist.”

According to Frank Hoogendijk, Bitcoin raises questions about institutions that were thought until recently to be indispensable. “The fact that you can now transfer money from A to B without the intervention of a bank is simply spectacular. Bitcoin and other cryptocurrencies prove that this technology can inspire trust, meaning that the mediation of a central entity is no longer necessary. This opens many doors to interesting applications.”

Back to smart contracts. Experimentation is currently ongoing with various test cases. For example, there is an insurance agency that automatically compensates aeroplane passengers if their flight is delayed or cancelled. Thanks to a smart contract, you can avoid an enormous amount of red tape. Without too much fuss, passengers receive compensations based on official flight data. That’s incredibly efficient!

Frank Hoogendijk thinks that smart contracts will lead to far-reaching changes in the financial sector. “That sector is often at the forefront of new developments. Decentralized finance (DeFi) is a concept that is starting to become increasingly prevalent. One example is the lending of cryptocurrencies. This may lead to innovative financial structures. The sky is the limit, the number of applications is endless.”

Niels Vandezande expects that smart contracts will considerably simplify supply chain management. Suppliers will receive payment as soon as the customer has taken receipt of the promised goods. If something goes wrong in the process, a proof of default will be issued. And that can all occur without a single human intervention.

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Joint pact between jurists and IT specialists

Will smart contracts soon completely replace traditional contracts? Things are not likely to develop so quickly. Some contracts are simply too complex and what’s more, there are formal requirements. For example, consumer law stipulates numerous strict regulations. A smart contract cannot yet accommodate these requirements.

Jurists and notaries need not worry: according to Niels Vandezande, they will continue to play an important role. “Jurists must ascertain whether smart contracts contain the correct clauses and whether they are correctly translated into code. Don’t forget that parties must still be able to read and understand legal agreements. The notary is and will remain a confidential advisor. There may be some applications within notarial practice, but that does not mean that the profession will become superfluous.”

Frank Hoogendijk thinks that blockchain technology developers must take legal realities into account, though the opposite is also true. Jurists must know the technology sufficiently to provide appropriate advice. The role of jurists, lawyers, and other legal professionals will only become more important, he says. “Technology opens a lot of doors, but those opportunities also involve responsibilities and risks. I think it is very important for developers to ensure they have sufficient legal support.”

Technology opens a lot of doors, but those opportunities also involve responsibilities and risks.

IT specialists and jurists will thus have to work together more intensively in the future. The university is already stimulating that dialogue. The recent programme in technology and law brings the two disciplines together and prepares students for the interdisciplinary nature of the field. In this context, researchers at the Brussels Campus published the book ‘Smart contracts: een overzicht vanuit juridisch perspectief’. This book seeks to provide (legal) professionals with critical insight into one of the potentially most disruptive applications of the decade. “It explores the concepts of blockchain and smart contracts more deeply and analyses their impact on financial law, company law, insurance law, copyright law, consumer law, notary practice, and private international law.”

Furthermore, the business world also has to get involved. “KU Leuven is very active in terms of applied research, in which the academic and corporate world come together. Such research is currently being conducted in the context of European programmes, such as Horizon 2020, and through Flemish initiatives like imec,” Niels Vandezande concludes.