How smart contracts can enable better supply chains

First created around 2014, with Ethereum, smart contracts at their simplest are a set of precoded instructions that will trigger outputs given specific inputs. The technology means that supply chain breaches or defaults can be automatically notified to all parties involved in a transaction, but requires thoughtful previous analysis of the best and most efficient parameters and the coding of the contract to be effective.

Written by Cristina Carrascosa Cobos of Pinsent Masons, the law firm behind Out-Law.

Smart contracts are underpinned by blockchain technology, providing decentralisation, verifiability and tamper proof security.

Supply chains are effectively networks of individuals, organisations, resources, activities and technology involved in the creation and sale of particular products. They involve collaboration and multiple levels of decision making processes which can be time-consuming, costly and inefficient.

To understand the benefits and advantages that blockchain and smart contracts can bring to smart supply chains, there's a difference that needs to be understood. Blockchain technology by itself has a range of features that can start to reduce these inefficiencies: the irreversibility of records, peer-to-peer (P2P) transactions and, most importantly, the data encryption added to its distribution and decentralisation create a solid and robust database. Running on top of these foundations, smart contracts are the pieces of software that allow parties to transact among each other with total transparency, utilising the security and efficiency of the blockchain.

Of course, both blockchain technology and smart contracts have limitations. As with every new technology, they require further development to meet each industry's needs. For example, smart contract deployment costs and transaction fees can be expensive. The Ethereum blockchain, given its decentalised and distributed profile, can suffer congestion, leading to high 'gas' fees. The developer community is working to address these limitations.

There are a number of smart supply proof of concepts (PoCs) currently being developed and tested. One of the most notable is the blockchain and supply chain project running at the Center for Transportation and Logistics at MIT in Boston. Built on the premise of a multi-party network - original equipment manufacturer, raw material provider, component manufacturer, inbound distributor, etc. - the project researchers describe how to implement a smart contract PoC in a technical way.

From a more practical perspective, there are several companies already running these sorts of solutions. Trazable, a Spanish start-up, is doing so in the food industry. With several successful pilot projects, Trazable lists a number of advantages to using smart contracts and blockchain in the supply chain: information sharing and product traceability becomes more transparent, and information asymmetry is reduced. Real time information to track processes allows for better collaboration between stakeholders, while ease of managing risks and disruption has become a key selling point for clients. As smart contract usage is always combined with a collaboration agreement or other legal terminology, defaults can be notified and tagged to a specific moment in time, making liabilities easier to identify and reducing legal costs.

ChainGo is another Spanish start-up that is now selling its blockchain and smart contract software to the container shipping industry after running successful PoCs with maritime transportation companies. Clients in this expensive industry have welcomed the total transparency of documents and signatures, and the way in which automatically updated information is made available to all the parties with no risk of tampering.

Of course, both of these companies have had to combine the technical development and use of the technology with the contractual documents that allow for valid transactions and enforcement.

Wider contractual mechanisms

A range of provisions which have historically been treated as 'boilerplate' terms will play an important role in bringing the smart supply chain to life. Force majeure, change control and governance mechanisms have typically proved to be too one-sided or lightweight to provide customers and suppliers with the contractual certainty needed to react at speed to the disruption caused by Covid-19.

New contracts are now all too frequently being delayed as the parties negotiate bespoke Covid-19 and Brexit clauses that seem destined to create a similar level of uncertainty to that found under standard force majeure mechanisms. Breaking that vicious circle requires the use of additional contractual levels that should allow the parties to deal effectively with as yet undefined disruptive events.

The creation of business continuity mechanisms linked to enhanced analysis of supply chain data should allow the parties to apportion responsibility for carrying out the key steps of the process, helping to match available resources to critical supply needs. Once available products are matched with priority requirements, flexible contracting mechanisms must be available to provide the legal framework needed to underpin any order.

Coding for smart contracts

Smart contracts are pieces of code that execute instructions. The name often creates confusion because it refers to a tool that is neither 'smart', nor a 'contract'. A more accurate term is obedient software.

Smart contracts require previous programming and the parameterisation of certain inputs. As a result, every smart contract needs an 'input' that has to be measured and coded, as well as a desired 'output'. Once executed, the smart contract will evaluate whether or not the input is correct and, if so, will return the relevant output.

As smart contracts can benefit from 'Turing complete' coding language, which allows for loops in the code, they can keep on executing instructions consistently and indefinitely, provided that the correct input is received.

Although the concepts underpinning smart contracts are reasonably simple, they nonetheless have the potential to enable an exponential increase in innovation. Using software that has the ability to self-execute introduces real potential for reducing delay and minimising user and resourcing inefficiencies.

In addition, smart contracts benefit from the properties of the blockchain technology which underpins their function. As a result, the digital self-execution of instructions in supply chain processes can be completely transparent, traceable and tamper proof. As blockchain processes allow users to 'audit' transactions while creating a single version of the complete database that is protected with cryptographic security, it is possible to start transforming data arising from unrelated supply arrangements into a smart supply chain.