A basic Ethereum smart contract is mainly used for escrow and payment of cryptocurrency funds based on the ETH blockchain, such as ERC20 tokens. Despite the name, a smart contract is not a legal contract—it is only meant to execute pre-agreed terms of a legal contract that already exists. A basic smart contract, however, is not flexible enough to accommodate or enforce complex legal agreements. For that reason, smart contracts in their current form cannot replace actual legal contracts. But a Ricardian smart contract can serve as both a smart contract and a legal agreement by accommodating the following:
- Machine readability
Obviously, a multi-faceted legal agreement with several clauses is much more complex than the simple terms within a basic smart contract. So, are we stuck with manually enforcing legal contracts without the benefits of smart contracts such as automatic settlements and reduced costs?
Fortunately, no. This is where Ricardian smart contracts come in. To execute a Ricardian smart contract, a written contract is parsed by software that subsequently determines whether each condition has been met. Not only can it read just like a written legal contract, but also contain machine readable tags that the software reader use to parse the text into executable code. The entire contract is converted into a cryptographic hash—or unique identifier. When a secure payment is made between the payer and payee, it will refer to the hash of that contract. This is why Ricardian smart contracts may emerge as the future of legal agreements stored on the blockchain.
Another problem with smart contracts using blockchains such as Ethereum and Cardano is that they are immutable—and thus too inflexible to adapt to changing business circumstances. Businesses, particularly manufacturers, operate in real-world environments. With the need to respond to rapidly-evolving circumstances, their contractual obligations can often change. A Ricardian smart contract offers these businesses the flexibility to change with these circumstances that regular smart contracts cannot. This is one reason businesses have not adopted basic smart contracts as quickly as many might have hoped.
A Ricardian smart contract essentially has two formats; a human-readable format as in an everyday legal document, and a coded digital copy that is readable by a machine. With Ricardian smart contracts, it is now possible to create a legally binding agreement that is readable and auditable by both humans and machines, and can be executed automatically by code. Rather than a basic smart contract, a Ricardian smart contract can better reflect the constantly changing real-world business environment that manufacturers, suppliers, and their customers operate in. Manufacturers could now adopt smart contract technology to ensure compliance and fulfill their legal obligations. While manufacturers and their partners can use a Ricardian smart contract to legally bind their agreements, they can also secure digital assets and rich context data in off-chain storage.
Businesses can initiate a production order and bind it to a Ricardian smart contract, which would be fulfilled once the manufacturer completes the order and all products have been successfully routed through the supply chain. Ricardian smart contracts can accommodate for increased complexity of legal agreements, provide the necessary flexibility to evolve with the ever-changing business environment.