Think about the last time you rented a car.
If your experience was like mine, you did not sign your contract until you got to the counter. There was no question about when exactly you’d need the car (since you’d already landed and knew your precise arrival time!) and you could decide what kind of car you wanted based on the weather (maybe a convertible to enjoy the sunny weather or an SUV for the snow!)
Believe it or not, this common situation teaches us a lot about how contracts work—and don’t work—in today’s business world.
I say “work” because, just like the contract at the rental counter, contracts signed by businesses exist in an environment, with outside factors influencing how well the contract performs. Instead of arrival time and weather, businesses must consider factors like exchange rates and geopolitical conditions.
I say “don’t work” because, unlike the contract at the rental counter, businesses haven’t historically had the ability to execute their contracts at the time of the transaction–as we put it, “nearer the edge.” Instead, they have negotiated and executed contracts that will affect transactions that take place months or even years in the future, with plenty of time for the environment to change.
These contracts are inevitably non-optimized for the future and for changing business environments, leaving contract parties vulnerable to negative commercial outcomes if something changes: Perhaps a supplier’s financial rating drops substantially, or macro-economic/political conditions change. Or perhaps the cost of living, demographics or social behaviors shift, affecting what was promised in the contract and the consideration for that promise. When something like the General Data Protection Regulation (GDPR) or Brexit comes along, the environment can alter radically for the contract, yet traditionally the contract itself remains the same.
AI and Blockchain Change the Rules of Contracting
However, new technology like artificial intelligence and blockchain are enabling another approach to business contracts, one that looks a lot more like the agreement signed at the rental counter—albeit with contracts worth millions of dollars!
With this technology, businesses are taking contracts to the edge – nearer the transaction, when they have a complete picture of the environment around the contract, enabling all parties to use the most up-to-date information. “Edge computing,” in which peripheral systems and devices are being empowered to react to the environment in real time, is having a profound impact across society, from healthcare to transportation. When the same metaphor is applied to contracts, contracting at the edge transforms contracts into living systems that interact with conditions around them.
To better understand what taking contracts to the edge of the transaction looks like, consider the example of a major global manufacturer. This enterprise has hundreds of thousands of suppliers, spread out across scores of countries.
In the past, the company would have executed a contract with these suppliers and then hoped that it had correctly predicted the conditions around the contract for its duration. Were currency rates to fluctuate wildly, and not in its favor, it had no recourse. In some cases, the company included a clause that dealt with currency fluctuation. But even then, it required manual review of thousands of contracts to keep track. Leakage was inevitable.
These days, though, the company uses digital contracts infused with AI to take much of the manual work out of monitoring performance.
Among the many benefits of digitizing contracts is the ability to create clauses that actively monitor the environment around the contract and react to it. The company has begun to use clauses that include a formula for calculating exchange rates, which monitor global exchange rates in real time. When conditions arise that trigger this clause, contract managers are alerted so they can take proactive action. It has completely eliminated a problem that just a few short years ago was considered an inevitable (and expensive) cost of doing business.
Self-Executing Contracts at the Edge
As contracts get digitized (the first time in history that this is happening at scale) and more organizations adopt advanced contract management platforms, it is inevitable that in the very near future we will see widespread adoption of contracts that not only flag clauses that require action, but actually take that action themselves (like automatically adjusting and releasing payment when an exchange rate fluctuates).
In fact, the technology for these self-executing contracts already exists and is being used. That technology is blockchain.
Blockchains that use distributed ledger technology allow for contracts that are self-verifying, self-executing, and autonomous. In other words, the contract doesn’t just flag an action. It takes the action!
This is the foundation for “smart contracts.”
With a smart contract, our manufacturer would enter into a contract with suppliers that have agreed upon conditions for what parts of the contract can be autonomously changed or what transactions can be autonomously triggered based on external conditions.
The nature of blockchains and distributed ledgers means that as these contract conditions are reached, and clauses are amended, they are recorded in such a way that neither party can repudiate or manipulate the record.
A New Era of Contracts
When contracts are being executed at the exact moment transaction conditions are met—that is when we are truly contracting at the edge.
Contracting at the edge of transactions leads to huge benefits in efficiency, lowered risk and better compliance.
In this blog we have focused on fairly straightforward conditions—currency, production metrics—but with artificial intelligence, companies will be able to monitor increasingly complex conditions to optimize business further.
This will be a new era of contracts. It will transform the way commerce is conducted. Welcome to the edge!