From Paper to Protocol: The Rise of Smart Contracts in Modern Commerce

Introduction

Traditional contracts have been the primary tool to formalise and enforce mutual understandings between two or more persons. Now, with technological advancements and modern digitalisation, the limitations of traditional contracts have become more apparent, such as slow execution, dependence on intermediaries, and lack of automation.

Smart contracts have emerged and offer a compelling alternative. Enabled by blockchain technology, smart contracts allow contractual obligations to be automatically executed once predetermined conditions are met. First conceptualised by Nick Szabo in the mid-1990s, smart contracts offer greater efficiency, transparency, and reduced reliance on intermediaries. As businesses continue to adopt digital solutions, smart contracts represent a shift from paper-based agreements to protocol-driven transactions within the commercial landscape.

What is a Smart Contract?

Smart contracts are digital contracts stored on a blockchain that are automatically executed when predetermined terms and conditions are met,[1] highlighting its automation attributes in contractual agreements within digital environments.[2] To implement a smart contract, its programmed code will be recorded and confirmed on a blockchain (or decentralised distributed ledger), making it tamper-proof.[3]

In modern commerce, blockchain technology has become increasingly relevant. Smart contracts operate through simple “if/when… then…” statements encoded on the blockchain.[4] A network of computers executes the actions when conditions are met and verified, such as releasing funds to the appropriate parties, registering a vehicle, sending notifications or issuing a ticket.[5] The blockchain ledger updates automatically when the transaction is completed.[6]

A practical example is crowdfunding, where crowdfunding platforms traditionally act as intermediaries between project teams and funders/investors. With the use of smart contracts, funds can now be held and released automatically upon completed and verified milestones, providing immediate certainty to all participants without relying on intermediaries.

Since the introduction of Ethereum in 2015, smart contracts have been increasingly implemented across diverse sectors such as finance, healthcare and supply chain management, highlighting their value in enhancing operational efficiency, transparency and trust within automated transactions.[7]

Why Smart Contracts Matter in Modern Commerce

Smart contracts offer four principal advantages over traditional contracts:

a. Speed: Traditional contracts are lengthy and usually involve more than one intermediary, such as lawyers, bankers, and agents. As smart contracts are digital and automated, they interact directly with data sources and internal systems, checking conditions and executing obligations near-instantaneously.[8] This reduces traditional time consumption significantly, as there is no paperwork to process and no manual reconciliation.[9]

b. Selective cost reduction: By removing some, if not all, intermediaries from the execution process, smart contracts eliminate the associated fees and delays.[10]

c. Transparency: The terms encoded in a smart contract are visible to all parties on the network. Upon being recorded on the blockchain, the transaction cannot be altered or deleted, which results in an auditable and transparent record.[11]

d. Security: Due to the immutable nature of smart contracts, each record on the blockchain is encrypted and linked to adjacent records, which would drastically reduce the chances of a person altering the record, or opportunistically modifying the record to the detriment of the other contracting party.[12]

Smart Contract & AI

In modern commerce, the integration of blockchain technology and artificial intelligence (“AI”) has become increasingly significant. AI-enhanced smart contracts are capable of supporting data-driven decision-making and introducing predictive capabilities, such as identifying potential risks or inefficiencies before they arise.[13]

For example, in the context of housing loans, the use of smart contracts and blockchain-based records reduces reliance on intermediaries by allowing transaction data to be shared securely across all nodes within the network. One illustration of this is Figure, a company based in San Francisco, which combines AI and blockchain technology to provide access to lines of credit and home loans. Borrowers are only required to complete a short questionnaire, after which they may receive pre-qualified offers, payment options and access to a video call with a notary to formalise the transaction.

As such, in this environment, blockchain and AI operate as complementary tools, enhancing the efficiency, accuracy and functionality of smart contracts,[14] and offering new opportunities for digital commerce.

Restrictions of Smart Contracts

Despite their advantages, smart contracts face various legal and practical constraints:

a. Legal enforceability: There is no specific legislation in Malaysia that directly governs the framework, use or deployment of smart contracts. However, several statutes contribute to the contemplated contractual objective of a smart contract, such as the Contracts Act 1950 governing the validity and enforceability of the terms of a smart contract; and the Digital Signature Act 1997 and Electronic Commerce Act 2006 providing recognition of electronic contracts and signatures.[15]

b. Practical evidentiary issues: Practical challenges remain in relation to statutory requirements. Under Malaysian law, contractual documents must be stamped by the Malaysian Inland Revenue Board before they can be adduced as evidence in court. In the context of smart contracts, difficulties arise in producing the contract in a form suitable for stamping for evidentiary purposes. As the existing administrative framework was primarily designed for traditional written instruments/agreements, the treatment of blockchain-based contracts in relation to stamping, evidentiary admissibility and other statutory formalities remain uncertain.[16]

c. Jurisdictional uncertainty: While smart contracts can operate across borders, not all jurisdictions recognise smart contracts, electronic contracts or digital signatures on the same terms. Furthermore, there is no international or standard consensus on the legal status of smart contracts and their obligations, and the need for comprehensive international standard guidelines remains.[17]

d. Not necessarily reduced cost: Smart contracts are executed, but not prepared, automatically. Together with the jurisdictional uncertainties, there remains a need to seek legal advice to ensure contractual certainty and observation, especially in Malaysia. In this regard, legal fees and costs may still need to be incurred by the contracting parties.

e. Inflexibility: Unlike traditional contracts, smart contracts do not allow for changes. Any adjustment or amendment requires the creation of a new contract.[18] Furthermore, as they cannot be modified and are programmed to be executed automatically, smart contracts lack flexibility for parties to verify whether contractual details, beyond the delivery of goods, are correct before releasing payment. As such, their application remains largely limited to relatively straightforward transactions.

f. AI-related in risks and uncertainties: While AI may enhance smart contracts by improving flexibility and data analysis, it also raises additional legal considerations such as issues relating to liability, transparency of automated processes and enforceability of adaptive contractual terms. These areas remain uncertain and require further regulatory clarity.

The Future

As blockchain technology continues to develop, contractual arrangements may gradually move beyond static written agreements towards systems where certain aspects of the contractual lifecycle are integrated into secure technological networks. In this regard, smart contracts represent not merely a new form of contract execution, but part of a wider shift in how commerce adapts to the demands of a digital and interconnected economy, particularly as emerging technologies such as AI has the potential to further enhance automated systems.

At the same time, the adoption of smart contracts has prompted ongoing debate regarding their practical suitability in all commercial contexts, in particular due to the absence of consistent regulatory approaches. Furthermore, certain complex agreements, such as film production, still require human involvement that automated protocols and AI-driven systems cannot easily replicate.[19]

Therefore, it is unlikely that smart contracts will entirely replace traditional contracts. Many of the disadvantages of smart contracts may be addressed as technology and legal frameworks evolve, potentially resulting in their wider adoption. With the advancement of technology, it is anticipated that future commerce will involve a hybrid model of law, AI and technology. As businesses move toward more intelligent operations, this combination is shaping up to be the next standard and businesses should be ready to adapt to the changes in this digital era.

This article was authored by Dato’ Brian Law (Head), Joel Prashant (Senior Associate), Tommy Wong (Senior Associate), Venecia Wong (Associate) and Law Jing Yu (Pupil-in-Chambers).

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Key Contacts

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Dato’ Brian Law | Head, Corporate and Commercial