Unlocking Global Trade: Exploring CISG's Integration with Smart Contracts for a Seamless Future

Aditya Bhansali, Member @BlockEdge Solutions

A contract is a mutual agreement between two parties that governs, defines and creates obligations for both of them, it sometimes involves the transfer of goods or services for consideration. The above-said statement is a general definition of contract that we have heard for quite some time now, but currently, as with the advancement of technology there is a new kind of contract in the market which is gaining a lot of popularity because of its features i.e., “Smart Contracts”. The term Smart Contracts was coined by “Nick Szabo” in 1994. He defined a smart contract as “computerized transaction protocols that execute terms of a contract”. They are tamper-proof and secure that is why many companies are leaning towards this type of contract and high sums of money are being paid to draft these types of contracts as it helps to reduce transaction cost and it can be drafted in certain ways which make the breach of the contracts very difficult. Due to the above-said advantages, many experts in the international trade arena are going on and on promoting the use of a smart contract for international sales of goods and services.

IBM Vice President of Blockchain Solutions, Mr. Ramesh Gopinath says, “the current supply chain system is inefficient as it relies on the physical movement of a huge number of paper documents for shipping transactions, this system is very vulnerable to fraud, human error and inadvertent delays”. “Head of Supply Chain and Transport Industries, Mr. Wolfgang Lehmacher, at the World Economic Forum” said, “that he sees blockchain and smart contracts as the solution to these transaction costs because of the potential of the technology to make payments and collaboration between traders easier and more transparent”.

Currently, the globally accepted method of contracting for international trade is through the norms prescribed in CISG (i.e., United Nations Convention on Contracts for the International Sale of Goods), but as above mentioned it is quite a time taking process, which includes tons of paperwork, presence of human error, frauds etc. to overcome these issues smart contract and blockchain has been seen one of the possible solutions. This article would aim to fill the gaps for CISG'S application to smart contracts, how does it work and what are the benefits of it with some real-life examples.

What are Smart Contracts?

Nick Szabo was an American scientist who believed that in the upcoming future, the way we conduct contracts is going to change completely and technology is going to play a big role in that is why he released a paper in which for the first time the term “Smart contract” was coined it stated, “Smart contracts are computerized transaction protocols that execute terms of a contract”. But what does it mean? In simple terms it means, it’s “a piece of electronic code” that does “something if something else happens”. One of the most common saying around smart contract is that it runs in the principle of ‘if this, then that” which means if this happens only then that will happen, for example, any person can write a code that if this month the temperature goes above 50 degrees Celsius in a particular area for more than 4 days then Raj a farmer will automatically get 1,00,000 rupees as crop insurance in his bank account at 11:59 pm on the fourth day. The purposes of smart contracts are endless. When it comes to smart contracts there are two main things that you need to know that makes them beneficial to everyone: -

1. They are Immutable: This means they cannot be changed, so as above stated “if this then that” it's because most smart contracts do something when they get triggered, they are just basically code on the blockchain that “gets run” and once it's on the “blockchain” it can never be “changed”.

2. They are Distributed: This means there are no discrepancies, which means one can't hire a lawyer to claim that it wasn't their agreement, these “smart contracts” are an “agreement” between a few parties online that can be “automatically executed” upon confirmation of certain conditions.

“Smart contracts are a piece of code designed to remove human error and issues”. The code is on a bunch of computers around the world, and anyone can see one’s smart contract and how you participated with it, so now we have a financial agreement that nobody can argue because they are code, they don’t change, and everybody has access to them.

Another example where these kinds of contracts can be used is in “Insurance Sector”. Anybody creates an entire insurance company with just a few smart contracts by writing something simple like this if A has already paid for a consignment from B and is getting that consignment shipped to his warehouse through a ship, now if during the transportation if the consignment gets destroyed due to a rise in the temperature, more than 60 degrees Celsius for more than 4 days in a row, then A will get $1000000 as insurance automatically. Importer A can be sure that if his consignment gets destroyed by a heatwave, the smart contract will know that it happened due to temperature changes and pay him out $1000000 insurance.

Now one might think how a smart contract, piece of code knows what’s the temperature on the ship is, well with the help of something called ‘Oracles’. Oracles are helpful tools to any smart contract essentially, they are a trusted source that gives real-world information to anything on the blockchain that requests it, they send real-world data to a smart contract.

Why Smart Contracts are being considered for International Trade?

Multiple actors and complex processes are involved in international commercial transactions, which necessitate the requirement of a large number of physical documents. Like for example, a common international commercial transaction entails procedures relating to border and customs procedures, “commercial transactions”, and “trade financing”, each of those processes, alongside a lot of paperwork relating to them. Furthermore, trade finance is typically a labor-intensive operation, involving more than twenty persons on average. International trade's paper and labor-intensive processes raise administrative expenses and are “prone to inaccuracy, losses, and corruption.”

In 2021 trade finance market was valued at 8 trillion USD and it is expected to reach 10 trillion by 2026, “existing models are complex, inefficient and costly requiring multiple parties and a significant level of manual processing”. “Banks have high operating costs and risks of fraud losses, while buyers and sellers face a plethora of paperwork and delays resulting in a poor customer experience, multiple paying points exist most notably, owner's manual review over the financial agreement, dependent on intermediary correspondent banks for payments, shipments delay due to numerous communication point and paperwork, high probability for fraud with disparate systems”. The above-stated issues are the reasons why there is a need for the smart contract in international trade and that is why a large number of transport and logistics businesses, and “governments”, begun to look into how “blockchain” and digitalization of international trade can benefit them.

Legal Validity of Smart Contracts

“Smart contracts” on the “blockchain systems” are somewhat a new innovation and there is an expansive scope of opportunities for what a “smart contract” can be. Since the The United Nations Commission on International Trade Law i.e., “UNCITRAL” presently can't seem to address whether the “CISG” is applicable to “smart contracts”, there is vulnerability as to if and when, along with a range of potential outcomes, a smart agreement is a legitimate agreement under the “CISG”.

“Smart contracts” that are referred to by and fused in a completely evolved composed arrangement are more straightforward to dissect for legitimacy in light of the fact that the examination can zero in on the conventional agreement components of the composed understanding. Smart contracts can only be covered by the CISG if they meet the contract formation requirements as mentioned under the provisions. A contract under the said Convention is restricted to that of an offer, administering the privileges of “buyer” and “seller” emerging from as, as intended under Article 4. Be that as it may, it expressly precludes pronouncing upon the subject of its actual legitimacy, a matter regularly passed on to the tact of "municipal laws". Consequently, the main issues that might emerge in the way of smart contracts being a subject upon the CISG, are, initially, the contract creation, i.e., whether the compulsory rules of "offer" and "acceptance" are met, as given under it, and furthermore, can the contract, overall, can be named under as "sale of goods".

How the Smart Contract will function?

Let us take a simple example of how the smart contract would look in action if replaced with a traditional contract.

Let us say company X agrees to buy 100000 units of oxygen cylinders from company Y. Now both parties will deduce this agreement into a blockchain code. The code will state “if Company Y delivers 100000 units of oxygen cylinders to Company X by 31 August 2022, at 5:30 PM IST, then Company X will pay 5,00,00,000 rupees to company Y.” now how will a blockchain will get to know that, did the goods actually have been delivered at the above-stated date and time, for that blockchain code will be connected to a data source known as “oracles”. As above explained oracles help to provide real-world data to the blockchain, this is done through IoT (internet of things). In this “smart contract”, “oracles” can be “company X’s” “computerized database of delivery and both companies’ bank accounts. Once company Y’s delivers 100000 oxygen cylinders is confirmed in Company’s X delivery system, the blockchain code will automatically initiate the release of payments of rupees 5,00,00,000 from company X’s bank account to company Y’s bank account without action required by the said parties or without any verification by any third-party clearinghouse”. This is just a raw example of how a smart contract work if given the scenario is so simple as stated above.

Real Life Examples

1. Maersk: IBM's one of the oldest tech solutions company and Maersk one of the biggest market leaders in the transport and logistic industry came together and are working to develop a blockchain-based “distributed permission platform” accessible by the supply chain ecosystem designed to exchange events data and handle document workflows. IBM and Maersk are using blockchain technology to create a “global tamperproof system” for digitizing workflow and tracking shipments end-to-end, eliminating frictions including costly point-to-point communications. The collaboration will launch with the potential ability to track millions of containers journeys per year and integrate with customs authorities on selected trade lanes.

2. Mizuho: One of the market leaders in the trade financing industry Mizuho has collaborated with IBM to digitize global trade financing through the use of blockchain and promote the reliability and transparency of global trade transactions. With the help of IBM, “they will make smart contracts where participant companies in the transaction can share information at the same time by utilizing the “distributed management of common ledger functions”. Trade documents will be stored between participants on the “blockchain” and carry out “cooperative processing”. “With the use of smart contracts, it would be possible to greatly shorten the time required for administrative procedures in various transactions and to speed up the process of amending letters of credit”. Mizuho and IBM will provide a new global trade digitization solution in global trade transactions through blockchain. This platform exchanges event information on trade transactions and is designed to process document workload promptly. This system may drastically reduce delays and fraud, potential to save fixed costs over 18 trillion dollars in the trade market.

3. Deloitte: Deloitte a world-renowned services provider has reimagined how trade financing can operate, “leveraging a blockchain-based infrastructure to drive efficiency, reduce cost and open up new revenue opportunities, like newer models of credit and funding guarantees backing the trade”. “The solution offers the core benefits of blockchain technology, such as real-time processing, automated smart contracts, and transparency across the value chain. It can be extended to areas beyond international trade finance, namely, marketplace model for trade finance processing, integration with global payments solution, and de-centralized document management system”. Overall, the solution is a means to enrich the customer experience with reduced cost and turnaround time and better transparency”.