Getting started with blockchain smart contracts

Few managers look forward to negotiating contracts. In large companies, there are many stakeholders to consult and it’s easy to make a misstep. And then there’s the expense involved in working with lawyers.

Smart contract technology promises to simplify the contract process and provide greater transparency.

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What are smart contracts?

Early approaches to smart contracts included some that were merely “augmented by technology,” says Houman B. Shadab, professor of law at New York Law School. “In a sense, you could view contract signing and management services like DocuSign as an example of [smart contracts].” Other approaches automated the production of traditional contracts using templates.

The latest generation of smart contract technology, by contrast, is based on blockchain and often performs activities such as payment processing. “Smart contracts can be used to automatically send a payment when a shipment is scanned and received at a customer location,” says Shadab.

Using blockchain to enhance, execute or improve contracts is still at an early stage. “In financial services, smart contracts are being used to automate routine tasks such as clearing and settlement,” says Shadab. Automating these processes means less back office complexity to manage, which translates into potential cost savings for large financial institutions.

Demystifying the supply chain

Do you know what components are in your computer and where they came from? This is becoming an increasingly important question as more companies come under scrutiny for their overseas manufacturing processes. (Consider, for example, the criticism that Apple has faced regarding working conditions at Chinese manufacturing facilities.) Unfortunately, current practices to track and monitor supply chains are difficult and rely on expensive audits.

[ Also on CIO.com: How smart supply chain management delivers value ]

But that may be changing, as several blockchain-based companies seek to improve supply chain management. One such company, Skuchain, which was founded in 2015, systematically tracks supply chain transactions — from order to manufacturing, customization and delivery. Skuchain provides enhanced transparency into the current location and status of supplies for buyers, sellers and lenders.

Reducing complexity and lowering costs associated with supply chain financing is part of the Skuchain story. In what Fortune described as “the first cross-border transaction between banks using multiple blockchain applications,” Commonwealth Bank (Australia) and Wells Fargo used Skuchain in October 2016 to track cotton shipments from Texas to China. Cost savings is achieved by permitting lenders to observe shipments and trusting the blockchain system rather than going through an expensive KYC (know your customer) process.

Getting started

Smart contracts on blockchain are at an early stage. “Public blockchain technology is comparable to the rise of ecommerce in the 1990s,” says Angus Champion de Crespigny, a senior manager at Ernst & Young who focuses on blockchain and related technologies. “There are many questions around how to use the technology effectively.”

“If a CIO was interested in experimenting with blockchain-style smart contracts, I would suggest starting small,” says Champion de Crespigny. “For example, use the technology for value transfer within the enterprise or to perform reconciliation activities.” This approach will give some confidence on how to use the technology prior to involving third parties.

Legal implications of smart contracts

There are three broad areas of concern to consider prior to experimenting with a blockchain smart contract. “Start by ensuring that smart contracts are designed in such a way as to be enforceable. Next, prepare for the scenario where the legal language of the contract and the code may at variance. Finally, prepare for opportunistic exploitation of the smart contract code itself,” says Shadab.

As a cutting-edge technology, there are many unknowns for blockchain smart contracts. “There are relatively few cases relating to smart contracts. One of the few was the Decentralized Autonomous Organization case which came to light in the summer of 2016,” says Shadab. Tens of millions of dollars were temporarily lost and later recovered. Weak cybersecurity processes appear to be part of the explanation.