Smart Contracts and Blockchain – Technology and the Law

At the same time, some new challenges and uncertainties must be overcome if there are to be more benefits than disadvantages from implementing these technological innovations. Before we explain what smart contracts are, we need to understand the blockchain network since it is through it that a smart contract is built.

The blockchain is a distributed database system operating as a process or ledger of transactions/information, made secure, immutable and efficient. In free translation, blockchain means “chain of blocks” since a chain of blocks is organized in a linear, chronological and connected way (hence its name), where each one stores specific data and information and cannot be deleted or altered.

The blockchain works, in simplified terms, as follows:

• Creating transactions: the process begins with the creation of transactions from a user’s wallet, which can be any type of information record, such as the transfer of a cryptocurrency, a smart contract or even the registration of a property;
• Block grouping: these transactions are grouped into a block, each of which contains several transactions and has a limited size;
• Block Hashing: the block is subjected to a hashing process before being added to the blockchain. A hash is nothing more than a fingerprint or unique identifier – a series of numbers and letters – that represents the content of a block, and any modification to the content will result in a completely different hash;
• Validation and Consensus Algorithms: in addition to the hashing process, the block must be validated using consensus algorithms, guaranteeing the transactions’ authenticity in the block. The validation/verification process will be able to tell when a block is not legitimate, as its hash will not match those recorded.
• Addition to the chain: once the block has been hashed and validated, it is added to the existing blockchain. Each block references the previous block, creating a continuous and chronological sequence. In other words, each block contains its hash and also the hash of the last block, linking both blocks and making the added block immutable;
• Information dissemination: information about new blocks is propagated throughout the network to ensure everyone has an up-to-date copy of the blockchain, avoiding divergences and maintaining the system’s integrity.

This sequence of steps is repeated continuously as new transactions are created and added to the blockchain. It is through this complex process that smart contracts can emerge.

Smart Contracts

Despite their name, not all smart contracts are contracts, as we usually understand them under Portuguese law. In reality, they are computer programs designed to autonomize, facilitate and/or guarantee the execution of agreements and contracts, which may or may not be classified as a contract, at least in a national legal sense.

They are designed, for example, to represent the intention of the parties to create some obligation, such as the purchase and sale of a good, the payment of the price or even the updating of a record, with their operations being recorded in a secure and immutable way, as they are implemented in the blockchain system explained above.

Its admissibility in Portugal

In Portugal, for something to be classified as a contract, in the technical legal sense, it must contain certain essential elements and assumptions relating to its formation, such as the existence of an offer and an acceptance and the agreement of the parties on all the clauses that one of them deems necessary for the deal. Suppose the smart contract includes all the elements and assumptions required for a particular type of contract. In that case, it will be classified as a contract of that type, or if it doesn’t fit into any, it can still be classified as an atypical contract – not typified by law – as long as it contains the essential elements of a business and is within the limits of the parties’ private autonomy.

On the other hand, even if a smart contract lacks one or more of these elements and is therefore not classified as a contract under Portuguese law, this does not mean that it is necessarily irrelevant from a legal point of view, as it may contain actions or tasks that are relevant to the law – for example, updating a register or carrying out a contractual obligation such as paying the price of a good.

Advantages of their implementation

Smart contracts eliminate the need for intermediaries and time-consuming manual processes, speeding up the execution of contracts and reducing the risk of human error and costs associated with certain bureaucracies.

Furthermore, as transactions and contract executions are recorded in blocks on the blockchain, the process becomes transparent and auditable, as the parties involved can track and verify the actions taken. They also cannot be altered, which generates a greater level of security between the parties.

Flexibility and customization are other benefits of this innovation since smart contracts can be adapted to meet various needs. Terms and conditions can be programmed according to the specific requirements of each transaction or business.

Another advantage lies in smart contracts being executed digitally, eliminating the need for physical space to store documents and records and not requiring the parties to travel in various situations, as would be necessary with the adoption of traditional physical contracts.

Issues and challenges

The introduction of smart contracts and blockchain can bring some challenges. One of them is precisely the irreversibility of the actions present in these technologies, as they are, as already explained, immutable systems, which can be problematic in the event of an error or change in circumstances.

In addition to this problem, the programming of smart contracts requires high precision since any error can lead to unwanted results and even security vulnerabilities.

Legal security problems can also arise. For example, in the case of a smart contract that may be a contract, it usually needs to be established which law the parties wish to apply to it. Given the electronic and delocalized nature of transactions carried out over the Internet, it may be challenging to determine which law or law may be used that one or both parties did not intend.

However, as blockchain technology and smart contract programming evolve, new solutions are expected to be developed to overcome these problems, even though national legislation still needs to be exclusively made for these figures. They are regulated by general contract law legislation and diplomas relating to electronic contracting and other matters associated with the agreement or business.

The understanding of these technological innovations is still limited for many people, so it is necessary to invest in education and awareness so that the population understands the potential and limitations of these technologies, which are not the future but the present in various situations and businesses worldwide.

As some people think, smart contracts and artificial intelligence will not replace lawyers and the like. Their work and service will ensure that smart contracts are concluded and executed safely by the law and protect their client’s interests.

To this end, jurists and lawyers who aim to provide advice on these new technological innovations must not only have a strongly consolidated legal base, but they must also have, or ask others to have, digital and/or computational knowledge related to blockchain since it is through blockchain that smart contracts are built.

Smart contracts will generally benefit commerce and the law, which, as we have seen in recent decades, is constantly adapting and must regulate these new technological innovations in detail so as not to frustrate its citizens’ expectations.

In conclusion, smart contracts and blockchain are transforming how we conduct business and transactions, bringing substantial benefits and requiring a deep understanding and a continuous effort to solve the challenges associated with these technological innovations.