The World Bank Group recently published a “FinTech Note” on Smart Contract Technology and Financial Inclusion in its “Finance, Competitiveness and Innovation” series. The note explores the potential of smart contracts to spur economic development and financial inclusion around the globe. The note explains the key technical and legal characteristics of smart contracts, delves into potential uses of the technology and, ultimately, raises important considerations for policymakers to weigh when implementing smart contract legislation. Below, we highlight a few of the key takeaways on the potential benefits of smart contracts and discuss how policy and legal decisions will impact the use of this technology.
The biggest advantage of smart contracts discussed in the note is the potential reduction of transaction costs resulting from the immutable and self-executing nature of blockchain-based smart contracts. Smart contracts can automatically be signed once certain agreed-upon conditions are met, and the terms of the contract cannot be altered. The note sees these key characteristics of smart contracts leading to increased transactional efficiency, lower enforcement and monitoring costs and decreased risk. These benefits can result in lower operating costs, the benefits of which can be passed along to consumers, and more time to pursue additional customers or opportunities. The reduction in counterparty risk resulting from the security of smart contracts can allow institutions to do business with a wider range of consumers. The note also highlights the possibility that smart contracts could be used not only between financial institutions and consumers, but also between consumers directly, which could cut down significantly on the costs of lawyers, advisors and other intermediaries.
The authors of the note view supply chain finance, insurance and consumer credit as areas where smart contracts may have a natural and effective application. Smart contracts can help close the wide gap in the availability of financing for small businesses, especially in developing nations and regions, by lowering costs for these entities to do business with large commercial or governmental entities and cutting down the risk for institutions. Insurance policies are particularly suited to take advantage of smart contracts’ automation by programming certain outcomes to occur if certain conditions are met. Lowering the costs of writing insurance policies and creating a higher level of trust among parties can make insurance policies more widely accessible. Similarly, the note describes potential benefits of using smart contracts to automate parts of the consumer credit process, such as credit applications, thereby making lines of credit more widely accessible to consumers.
Given smart contracts’ potential global economic benefits and positive impact on financial inclusion, the World Bank describes several concerns that policymakers should weigh in order to effectively implement the use of smart contracts. These recommendations primarily focus on how to incorporate smart contracts into existing legal and regulatory frameworks. For example, many countries have existing financial consumer protection and customer due diligence laws. Certain smart contract features, such as possible anonymity of the parties, may pose issues with customer verification or anti-money laundering laws that rely on vetting the parties to an agreement. The note points out that these issues can likely be solved by requiring certain technical specifications of the smart contract or the underlying blockchain. Legislating the use of smart contracts will require a nuanced approach to defining the types of contracts and technologies that can be used instead of a broad legalization of the use of smart contracts.
Beyond these finer technical points, many basic legal concepts surrounding smart contracts will also need to be addressed by legislation. The gating legal issue is whether jurisdictions will allow smart contracts to be considered legally-binding contracts meeting the typical contract pillars of offer, acceptance and consideration, or whether certain smart contracts may be defined as “general terms and conditions” or given a similar legal status. These determinations will hinge on fundamental legal questions such as whether an offer, or a “conditional” offer, has been made, or whether certain standards of fairness and clarity are met as applicable to “general terms and conditions.”
The authors of the note also predict a larger number of post-execution disputes if smart contracts become widely used as parties may dispute whether a smart contract should have been executed, which will give rise to legal issues such as whether the code underlying a smart contract can be admissible as evidence in court. Additionally, in order for smart contracts to become widely available and truly address the global issue of financial inclusion, such contracts will need to interact with data sources and government entities in order to be useful, which invites a host of third-party legal issues.
The uses and benefits of smart contracts are gaining more recognition by global economic and financial institutions like the World Bank. However, the effectiveness of smart contracts will ultimately be defined by the legal and policy issues that will need to be properly addressed in order to fully realize the potential economic benefits. As smart contracts become more widely adopted, we will most likely see a spate of new legal issues related to novel applications of smart contracts which will require more nuanced, and constantly evolving, policy and case law in order to reap the benefits of smart contracts.