Blockchain in Supply Chain: Article 5

One benefit of blockchain includes its ability to harness the
power of smart contracts. 

What is a Smart Contract?

Although the term “smart contract” sounds like a legal
instrument, a smart contract is actually a computer program that
performs a task when triggered by the occurrence of a predetermined
event.  Smart contracts live on blockchain, which processes
the terms of the smart contract, thereby enabling the smart
contract to automatically execute the coded task when the
triggering event occurs. 

Nick Szabo, a computer scientist and cryptographer who coined
the term “smart contract,” likens a smart contract to a
vending machine.¹  A consumer
inserts money into a vending machine (i.e., satisfies the
condition of the contract), and the vending machine automatically
dispenses the treat (i.e., honors the terms of the
“contract”).

Oracles

In order to trigger the automatic performance of a function, the
smart contract uses “oracles” to receive information from
the outside world. 

Inbound vs. Outbound Oracles

An oracle can provide data from the outside world for
consumption by the smart contract living on the blockchain (an
“inbound oracle”) or allow smart contracts to send data
to the outside world (an “outbound oracle”).  As an
example of the latter, an IoT-enabled lock functions as an outbound
oracle when the smart contract triggers the lock to unlock
automatically if a party transacts a certain payment across the
blockchain.

Types of Oracles 

Types of oracles include hardware, software, and human:

• Software Oracles. Software functions as an
  oracle by connecting smart contracts to online data sources, such
  as temperature, commodity prices, and transportation delays.




• Hardware Oracles. Hardware oracles include
  pieces of equipment that communicate real-world information to the
  smart contract. RFID sensors, for instance, can detect
  environmental changes that link to blockchain to trigger a smart
  contract.




• Human Oracles. Humans act as oracles when they
  provide real-world information to a smart contract, often with
  cryptography in place to ensure the proper individual provides the
  information. Another human-based approach to oracles uses a
  consensus protocol, meaning that different humans vote on the input
  to provide to the oracle. In any case, using a human oracle
  introduces the potential for human error. A party may nonetheless
  opt to use a human oracle when a decision requires subjectivity or
  when the nature of the triggering event makes continuous monitoring
  difficult.

In order to strengthen the trust of the oracle system, supply
chain members can use a combination of oracle types for the same
smart contract.

Examples of Smart Contracts for Supply Chain

In supply chain, smart contracts are particularly useful for
releasing payment, recording ledger entries, and flagging a need
for manual intervention.

• Releasing Payment.  A party could use a
  smart contract as a means to automatically release payment upon the
  satisfaction of a condition. For example, two parties, such as a
  manufacturer and a supplier, could set up digital wallets and a
  smart contract in order for the manufacturer to pay the supplier
  for the purchase of goods. After the manufacturer inspects and
  accepts the goods, the smart contract would automatically move cryptocurrency from the manufacturer’s
  digital wallet to the supplier’s digital wallet to effect
  payment.




• Recording Ledger Entries. A party could write
  a smart contract to record to a blockchain ledger if some specified
  event occurs or does not occur. For example, if an IoT- enabled
  device detects the opening of a container during transit, a smart
  contract could automatically record this information. A party may
  find such monitoring particularly useful for goods that require a
  tight chain of custody, such as with the transport of
  pharmaceuticals.




• Flagging a Need for Manual Intervention. Smart
  contracts are also useful for flagging the occurrence of an event
  that requires manual intervention. For example, for
  temperature-sensitive products, a smart contract tied to
  temperature monitors could alert all concerned parties if an
  out-of-range temperature occurs. This would allow the parties to
  promptly take action to correct the temperature, conduct an
  investigation into the reason for the out-of-range temperature and,
  when necessary, pull the affected products (and only the affected
  products) from the stream of commerce.

When is a Smart Contract a “Contract” from a Legal
Perspective?

A smart contract may constitute a legal contract if the smart
contract contains the elements of valid offer and acceptance, as
well as adequate consideration.  The general principles of
contract law define an offer as a manifestation of willingness to
enter into a bargain² and
acceptance as an agreement to that offer,³ while consideration denotes
something of value exchanged by the contracting parties.⁴

In addition, for the smart contract to constitute a legally
binding contract for the sale of goods, the contract must
also satisfy the various requirements of Article 2 of the Uniform
Commercial Code (UCC),  including its statute of frauds
requirements and its requirement that the contract set forth a
quantity in order to be enforceable.⁵  Practitioners will need to
evaluate on a case-by-case basis whether a smart contract meets
these elements and therefore represents a binding legal contract
for the sale of goods.

The Uniform Law Commission and the American Law Institute
established a Uniform Commercial Code and Emerging Technologies
Committee⁶ to study and evaluate the
UCC in the context of “among other issues, distributed ledger
technology, virtual currency, electronic notes and drafts, other
digital assets, payments, and bundled transactions,” and the
Uniform Law Commission released an issues memorandum⁷ discussing these topics in July
2021 following two years of committee meetings.  While smart
contracts have been part of the discussion, no formal evaluation
for smart contracts has been performed by the Uniform Law
Commission or the American Law Institute, leaving open the
opportunity for clearer guardrails in the future as to whether a
smart contract amounts to a legal contract. 

Smart Contracts vs. Smart Legal Contracts

Smart contracts are not to be confused with smart legal contracts.  While a smart
contract is a computer program coded to effectuate an outcome upon
the occurrence of a triggering event, a smart legal contract is
“a legally binding agreement that is digital and able to
connect its terms and the performance of its obligations to
external sources of data and software systems.”⁸  The Accord Project makes clear that, although a
smart legal contract can use smart contracts via blockchain
technology, a smart legal contract can also be created using
traditional software systems without the use of blockchain.⁹

Vulnerabilities

While properly coded smart contracts could dramatically increase
efficiencies in supply chains, companies face a risk that their
smart contracts contain bugs or other technical issues such as data
block corruption. There are three common types of vulnerabilities
that arise from improperly coded smart contracts: greedy contracts,
prodigal contracts, and suicidal contracts.¹⁰

In addition, another complicating factor for using smart
contracts is the inability of a non-coder to read whether the smart
contract actually does what he or she wants it to do.  Even
though the parties may have a traditional text-based agreement in
place that provides the parameters for the smart contract, the
programmer could code the smart contract in a way that is not
consistent with the written agreement.  If the businessperson
were unable to read code, he or she would have no way to verify
whether the coded smart contract matches the text-based
agreement.

Finally, because the immutable nature of blockchain also extends to
smart contracts (which live on a blockchain), once a programmer
codes and deploys a smart contract, immutability prohibits the
addition of any new functions to the smart contract. 
Upgrading and otherwise altering smart contracts is an active area
of research in the blockchain community, and mechanisms for
altering smart contracts and best practices are still being
developed.

While smart contracts could increase efficiency in the supply
chain, real risks exist that the coder could set the smart contract
up improperly or that the smart contract fails to account for a
change in circumstances.  Businesses seeking to employ smart
contracts will need to weigh the pros and cons carefully and
allocate the risks between the participants in the smart contract
accordingly.

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1. Levi, Stuart D. and Alex B. Lipton, An Introduction to Smart
Contracts and Their Potential and Inherent Limitations,
Harvard Law School Forum on Corporate Governance,

2. See RESTATEMENT (SECOND) OF CONTRACTS §
24 (AM. LAW INST. 1979)

3 .See RESTATEMENT (SECOND) OF CONTRACTS §
22-23 (AM. LAW INST. 1979)

4. See RESTATEMENT (SECOND) OF CONTRACTS §
71 (AM. LAW INST. 1979)

5. See Uniform Commercial Code §
2-201(1)

6. Uniform Commercial Code
and Emerging Technologies Committee, Uniform Law
Commission, (last retrieved September 7, 2021)

7. Uniform Commercial Code
and Emerging Technologies, Uniform Law Commission (July
9-15, 2021)

8. Frequently Asked
Questions, the Accord Project (last retrieved August 22,
2021)

9. Id.

10. Groschopf, Wolfram et al., Smart Contracts for
Sustainable Supply Chain Management: Conceptual Frameworks for
Supply Chain Maturity Evaluation and Smart Contract Sustainability
Assessment, Frontiers in Blockchain (April 9,
2021)

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