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The benefits and limitations of smart contracts in trade and supply chain

The benefits and limitations of smart contracts in trade and supply chain

Computers can make some parts of contracts far more efficient but there are other areas that need to be kept with humans.

At our Emerging Digital Futures in Trade client event in 2016, KWM Partner Scott Farrell demystified smart contracts. They’re simply about finding the calculations and processes in a commercial arrangement that a computer or machine can perform more efficiently than a human.

Simple loan agreements can be seen as smart contracts in the sense that the interest rate isn’t calculated from scratch each time interest is due. Instead, it is referenced to an interest rate benchmark like BBSW that is calculated by a process that neither party performs at a human level for that loan contract.

Smart contracts take this idea further. For greater efficiency, the processes or calculations that the parties don’t need to manually undertake are written into a contract in a language that a computer understands. To be really effective this isn’t just a means of executing a contract – it is written into the contract and forms part of it.


Reason versus logic

The executable code of a smart contract could apply to payments by automatically deducting loan repayments from borrowers’ appropriate bank accounts.

While very efficient, this raises the critical issue of the limits of automation. If repayments are missed, we don’t necessarily want the computer to automatically initiate and conduct the default management process. There are too many additional factors to consider. What happens when someone defaults isn’t merely a question of logic, but also a question of reason. When reason is necessary, then a truly “smart” contract will look to a human, rather than a machine, for direction. Sometimes a reasonable person is necessary, not a logical machine.

Similarly, the ability to breach a contract highlights the need for both automated and non-automated elements in smart contracts. Contract breaches usually have consequences, such as paying for the damage caused. But there can be sound commercial reasons for breaching a contract and it is important to have this ability. Locking everything away in a fully-automated smart contract is giving away this element of optionality that has real value.

There are so many rights, options and abilities in commercial transactions that it isn’t realistic to write a logic path that entirely covers the relationship. The automated logic path should be used when it is most efficient, and human discretion and judgment should be used in other circumstances. That would make a really “smart” contract.


Solving the lack of trust

When adopting new technology Scott advises asking why you are doing it, what are you trying to solve, improve or make more convenient and is this the best way to do that. Sometimes a new technology can be more of a solution looking for a problem than a solution to a problem.  It is also important to think about the broader impact. Could the result be less contact with customers? This is unlikely to be beneficial to the business.

There is a good fit between blockchain technology and trade finance. Trade finance transactions are often between parties separated by distance, country and culture, making it difficult to establish trust. This has resulted in conventions that focus on linking relationships with documents. Blockchain could make this more efficient. It can not only solve the document-intensity of trade finance, but also the problem that documents were trying to solve - trust. Through its distributed structure blockchain provides an engine of trust for disparate commercial parties.


Taking the worry out of fin

As a member of the government’s Fintech advisory group, it’s no surprise that Scott believes fintech can deliver on the hype and be sustainable.

Fintech is about making people’s lives easier, using “tech” to take the worry out of “fin”. If finance providers want to make their customers’ lives easier, they will keep working to improve. Technology is a primary tool for this purpose. To ask if fintech is sustainable is like asking if progress is sustainable. 

Turning that around, you could ask is finance perfect? If not, then the change in finance to make it better is sustainable. The fintech revolution might change its label but its advances won’t stop while customers want improvements in finance.

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