This Article is written by Sayan Chowdhury, a Second Year Law Student of South Calcutta Law College

Introduction:

A smart contract is any contract that is digitally equipped and that automatically executes the terms of an agreement by itself. The term describes computer program code that can facilitate, execute, and enforce the negotiation or performance of an agreement using blockchain technology.

To explain in layman’s terms, we can say that the smart contract is a tiny computer program that stores the terms and conditions of a contract inside a blockchain. This purely digital type of contract runs on blockchain nodes and cannot be changed. So, any contract is a smart contract if it stores rules, verifies rules, is self-executing, and runs in a decentralized manner.

Do smart contracts hold up under Indian laws?

While India does not have specific laws/statutes/regulations related to smart contracts, there are provisions under the Contracts Act, Evidence Act, and IT Act, which can be applied to smart contracts. Yet, these create limitations for the use of smart contracts, as the legislation has not been updated to reflect technological developments.

Section 10 of the Indian Contract Act, 1872 speaks about the essential nature of a contract – ‘all agreements are contracts if they hold the free consent of parties willing to contract, for a lawfully accepted consideration and with an object’. When the same is applied to smart contracts, we see that there is offer and acceptance, hence, it could be said that smart contracts are validated and enforceable under Indian law. But offer and acceptance are basic and can be proved easily. However, the consideration has to be a legal one – for example, are such contracts specifically recognized under the law?

The IT Act provides ‘that digital contracts are valid contracts and enforceable in the court. However, they should have the Digital or Electronic Signature by the Certified Authority authorized by the government.’ Here, smart contracts contradict this clause as it is decentralized in nature and there is no involvement of a government-controlled authority.

Some of the essential characteristics of a smart contract are as follows-

I) No physical submission of documents is required for the completion of the transaction.

II) The details of the transactions are recorded on the decentralized ledger wherein the details are protected, and user identity is anonymous.

III) It is not possible for anyone to alter the terms and conditions of the contract once the transaction is complete.

IV) Transactions under smart contracts are irreversible.

Indian Contract Law:

The Indian Contract Act 1872 is a comprehensive guide that governs contracts and agreements in India. The act was passed to provide a legal framework for contract law and has been amended several times over the years to keep up with changing economic conditions.

Smart Contracts:

Smart contracts are digital contracts stored on a blockchain that are automatically executed when predetermined terms and conditions are met. Smart contracts are typically used to automate the execution of an agreement so that all participants can be immediately certain of the outcome, without any intermediary’s involvement or time loss. They can also automate a workflow, triggering the next action when predetermine conditions are met.

What is the difference between a traditional contract and a smart contract?

Some of the major differences are discussed below

Comparison of Traditional Contracts and Smart Contracts

- Nature

- Traditional Contracts: Physical contracts with printed documents.

- Smart Contracts: Entirely digital, composed of computer code provided online.

- Third-party Interference

- Traditional Contracts: Require third-party involvement for contract creation and enforcement.

- Smart Contracts: No intermediaries needed; automatically executed.

- Mutability

- Traditional Contracts: Susceptible to misinterpretation or alteration.

- Smart Contracts: Secure and immutable once the transaction is completed.

- Time

- Traditional Contracts: Execution can be time-consuming, often taking days.

- Smart Contracts: Automatically executed within minutes, depending on the contract.

- Maintenance

- Traditional Contracts: Physical storage requires high maintenance for safekeeping.

- Smart Contracts: Eliminates the need for physical storage.

- Process

- Traditional Contracts: Manual.

- Smart Contracts: Automatic.

Benefits of Smart Contracts

Smart contracts offer several benefits, including:

- Increased efficiency: Since the contracts are saved on computers, they carry out the functions as soon as the prerequisites are met.

-Trust and transparency: Because there’s no third party involved, and because encrypted records of transactions are shared across participants, there’s no need to question whether information has been altered for personal benefit.

- Security: Blockchain transaction records are encrypted, which makes them hard to hack. Moreover, because each record is connected to the previous and subsequent records on a distributed ledger, hackers have to alter the entire chain to change a single record.

- Savings: Smart contracts remove the need for intermediaries to handle transactions and, by extension, their associated time delays and fees.

Limitations of Smart Contract

There are certain limitations of smart contracts which are as follows: -

- Difficult to Smart contract processes are almost impossible; any error in the code can be time-consuming and expensive to correct.

- Possibility of loopholes: According to the concept of good faith, parties will deal fairly and not get benefits unethically from a contract. However, using smart contracts makes it difficult to ensure that the terms are met according to what was agreed upon.

- Third-party: Although smart contracts seek to eliminate third-party involvement, it is not possible to eliminate them. Third parties assume different roles from the ones they take in traditional contracts. For example, lawyers will not be needed to prepare individual contracts; however, they will be needed by developers to understand the terms to create codes for smart contracts.

- Vague terms: Since contracts include terms that are not always understood, smart contracts are not always able to handle terms and conditions that are vague.

Conclusion

Traditional contracts and smart contracts both play crucial roles in the modern economy. However, smart contracts, driven by blockchain technology, are poised to revolutionize industries by reducing costs, improving transparency, and eliminating the need for intermediaries.

Despite their limitations, smart contracts hold immense potential for the future of decentralized transactions. As legal systems adapt and technology improves, smart contracts could become the norm in industries where automation, efficiency, and trust are paramount.