We often hear about “smart contracts”, but it is not always clear how useful they are or where they can be applied.

Let’s start by saying that, in essence, a smart contract is nothing more than a computerised transaction protocol that executes the terms and conditions of a contract. The purpose of such tools is to automate and simplify certain processes.

Consider, for example, the case of insurance policies for flight delays; normally, when the insured event occurs (i.e. the delay), the insured must get in contact with the insurance company in order to receive, at the end of the investigation and unless there are objections, the compensation foreseen with a time frame that can be quite long.

The purpose of a smart contract in this case is to automate the process of claiming damages and paying compensation. Specifically, the insured and the insurance company negotiate the terms of the contract (e.g. the severity of the delay, the amount of compensation, etc.), and then translate the negotiated clauses into computer instructions (algorithms), which are “triggered” automatically when the event occurs. To make it simple, the compensation will be automatically paid into the insured’s bank account as soon as the information on the plane’s delay is recorded by the smart contract.

However, for the smart contract to achieve the desired automatic effect, the occurrence of the contractual event, i.e. the delay of the aircraft, must be notified to the smart contract. Without this fundamental step, the clauses could not be activated and would remain just a line of code on an isolated device. For this specific reason, the reliability of the source of information to which the execution of the clauses is linked is a crucial aspect in the negotiation phase between the parties, since once it has been selected, its reliability and impartiality cannot be challenged in the course of the relationship.

Once the negotiation phase has been completed, the next issue is the accuracy of the implementation of the smart contract and its accountability. For some time, in fact, the large-scale spread of these instruments has been hampered by the lack of a third-party intermediary who would certify the effective compliance of the lines of code – whose writing must necessarily be entrusted to a technician – with the will of the parties, as well as the inalterability of the instructions over time and their ready verifiability by all interested parties. This function, which in traditional contracts is carried out by professionals such as lawyers and notaries, who guarantee with their work the official nature of what was agreed and the protection of the interests of their clients, is in fact unknown to the world of algorithms.

This, however, has changed with the advent of the blockchain. The latter is in fact a register of information grouped in ‘blocks’ that are almost impossible to alter and are potentially accessible to any party interested in verifying their content.

By inserting the smart contract into a blockchain through the payment of a cryptocurrency “commission”, a twofold result can be achieved: the verifiability of the information entered (which is thus removed from the exclusive sphere of control of the programmer) and the certainty of this information, which cannot be altered or manipulated without the knowledge of either party. In essence, the blockchain performs the function of a digital notary, archiving and formalising the will of the parties when the contract is concluded. Subsequently, upon the occurrence of the event referred to therein, the so-called “oracles” – blocks that serve to transmit information from the world to the blockchain – communicate it to the registered contract, which will execute the instructions for which it was programmed.

In addition to the insurance field, other areas in which these instruments can be applied are M&A – for example, the possibility of obtaining immediate credit of sums in an escrow account upon the occurrence of the event referred to in the deed of acquisition – and the financial field, where the degree of digitalisation is already very high and where relevant information is already exchanged through computer applications that have an immediate effect on the value of stocks. By way of example, the occurrence of a war event in a given country almost simultaneously causes a collapse in the value of the relative government bonds, just as the statements of central bank presidents are immediately recorded by the financial system, raising or depressing the trend of the international stock exchange over the course of a single day.

From the above examples, it is clear that smart contracts are undoubtedly useful in certain areas, although it is still too early to say that they are destined to replace “traditional” contracts.

This is because not all clauses of a contract can be applied and interpreted through automatisms (e.g. clauses referring to uses and practice), nor all contracts provide for obligations that can be performed by a computer. It is sufficient to think about the clauses providing that the renewal of the contract is subject to the successful completion of a trial period – necessarily linked also to evaluations of personal nature that cannot always be codified ex ante – or to events of force majeure that by their nature cannot be regulated ab origine.

To this must be added that it is still not clear how a smart contract that contains errors or no longer corresponds exactly to the will of the parties can be modified, especially from the moment of its registration on the blockchain. The paradox in such cases would be the automatic and potentially “infinite” execution of an arrangement of interests no longer acceptable to the contracting parties themselves. This aspect also makes it unlikely that smart contracts can be used to regulate, for example, relationships of duration, precisely because the intrinsic uncertainty connected to the changing conditions over time would be incompatible with the ex ante determination of any possible contractual consequences.

Without prejudice to above important considerations, however, it is worth highlighting the great advantage in terms of reducing transaction costs that widespread adoption of this technological innovation could bring. This is especially true in all those cases where the needs to be met do not require complex negotiation; therefore, it is not unlikely that smart contracts will start to be implemented in all those cases where the parties prefer the speed and certainty of automatic performance of an obligation over the renegotiability or flexibility of the relationship.

In conclusion, there is no question of the usefulness and economic savings that can be achieved by using smart contracts. What is certain is that, as is often the case with any technological innovation, these advantages will only be truly perceived through significant integration and adoption of these tools in our society.

However, it can already be said that smart contracts will find wide application especially in standard relationships where a minimum contribution in terms of creativity and customisation of contractual solutions is required.

Under a different point of view, a real challenge for legal professionals is to be able to integrate such tools into traditional contracts in order to improve and enhance the effectiveness of the legal protection provided. This could be a truly “smart” objective to be achieved.