By
Dimitar Bogdanov
May 17, 2021
4 Min Read
Perhaps the most significant effect of the constant evolution and advancement of technology is that it inspires new ways of thinking and enables us to come up with revolutionary ideas that would have been unthinkable in a different technological landscape. But perhaps a less appreciated aspect of technology maturation and evolution is that it can breathe new life into old ideas. To make visionary concepts that have been conceived in the past, but may have at the time seemed like science fiction, possible. This is especially evident in the shift from traditional contracts—human-readable, legal documents—to digital formats that combine legal enforceability with technological efficiency.
We see those two sides of technology manifested clearly in the still-nascent field of blockchain and distributed ledger technologies (DLT). On the one hand, it has inspired new types of services and applications, such as flash loans and yield farming. On the other hand, blockchain developers are finding ways to utilize concepts that likely seemed impractical in the pre-blockchain technological landscape. Concepts like smart contracts and the subject of this article, the Ricardian contract. Ricardian contracts represent a new form of digital agreement, combining human-readable legal terms with machine-readable code to ensure secure, transparent, and efficient transactions. They are also highly relevant to the accounting world, as they link legal agreements with financial record-keeping, providing a transparent and auditable record of transactions.
As we hinted above, the Ricardian contract is an old concept that predates the invention of blockchain technology and by quite a bit. It was first proposed by programmer Ian Grigg in 1996 as part of the Ricardo Payment System. The concept described a new type of legal document readable by both humans and machines. A Ricardian contract is written using a combination of legal prose - perfectly understandable to lawyers and even ordinary people - and a markup language that allows for the defining elements of the agreement to be expressed in a machine-readable format that can be executed by a computer program. This markup language enables the contract to be translated into machine readable code for execution on blockchain systems. The written contract is then digitally signed by the parties involved and cryptographically verified. The Ricardian contract serves as a legally binding document that can be enforced in court. It also acts as the central parent document, serving as the foundational legal reference for all aspects of the transaction. The importance of the signed original document lies in establishing legal validity and intent between the parties. The private key is used to digitally sign the Ricardian contract, ensuring authenticity and security.
While revolutionary, the concept didn’t get much traction when it was first introduced, because the technology available at the time was not sufficient to unlock its full potential. However, this is no longer an issue, thanks to the advent of blockchain technology, which seems to have everything to make the most of the idea.
In the context of blockchain technology, a Ricardian contract is a type of smart contract that is readable by both humans and machines. In essence, Ricardian contracts offer a convenient way to merge the world of legal agreements and blockchain technology. Now, let’s take a closer look at how they work.
Ricardian contracts work by serving as both human-readable legal agreements and digital elements linked through cryptographic hashes, enabling secure, legally binding transactions on a blockchain network.
At the heart of a Ricardian contract lies a human-readable legal agreement between two or more parties. That part of the contract needs to be written preferably by lawyers and in accordance with laws, rules, and regulations of a particular jurisdiction. The ricardian contract captures the details of the agreement, including terms, signatures, and hashes, ensuring all essential information is legally recorded. Once the legal framework has been agreed upon and signed by the parties involved, the contract is then signed and stored on a blockchain. Subsequent transactions refer to the contract’s hash. The ricardian contract's hash and the hash of the contract serve as unique digital fingerprints, ensuring the integrity and authenticity of the agreement. The contract is securely stored and referenced on the blockchain network, where blockchain transactions are executed and validated for transparency and security. Ricardian contracts can involve multiple transactions between trading partners, each legally recorded and referenced by the contract's hash, providing a clear audit trail.
Notably, Ricardian contracts are live contracts, meaning that they can be changed to reflect the outcome of stipulated events. Ricardian contract splits can occur, dividing responsibilities and domains between parties as needed for multiple transactions. The legal contract formalizes the agreement and produces legal contract results, ensuring all obligations are enforceable. Ricardian contracts legally record the obligations of trading partners, creating a contractual bond that is recognized and enforceable in court. The contract's legality depends on its validity period and enforceability over time, which should be clearly defined. Not every Ricardian contract is a smart contract, and vice versa; Ricardian contracts focus on legal enforceability, while smart contracts are automatically executable. Operating contract codes and readable code for execution enable automation and transparency, making the process efficient and clear. Ricardian contracts facilitate secure payment by referencing secure payment cites and confidential and secure payment mechanisms, protecting sensitive transaction data. Ricardian contracts connect the legal domain with accounting and transaction processes, ensuring all aspects are systematically managed. Ricardian contract splits and multiple transactions are managed within the system to address complex agreements. The role of two parties is central in establishing and verifying the contract, ensuring mutual agreement and legal standing. It is important to include provisions for what happens if one of the parties dies, to ensure the contract remains adaptable and enforceable in unforeseen circumstances.
The blockchain space is already quite accustomed to smart contracts, a type of self-executing piece of software that on the surface seems to resemble Ricardian contracts quite a bit. And indeed, all Ricardian contracts are also smart contracts. However, smart contracts are not Ricardian contracts. A basic smart contract is not necessarily a Ricardian contract, and vice versa, as they serve different purposes and have distinct functionalities.
The main difference between the two is that, despite their name, smart contracts are not legal documents, unlike their Ricardian counterparts. In fact, smart contracts are not legally binding agreements, whereas Ricardian contracts are designed to be legally enforceable. Rather, smart contracts are a mechanism for ensuring trust and automating operations in blockchain-based systems. As such, they are written in code and don’t need to be human-readable. In contrast, a ricardian smart contract acts as a framework that combines legal enforceability with blockchain automation, defining the contractual relationship between two or more parties and can be used outside a blockchain. Ricardian contracts operate within a specific legal domain, connecting legal frameworks with blockchain processes.
Whereas a smart contract is essentially a set of instructions on how to execute certain actions based on whether certain requirements have been met, a Ricardian contract also provides the legal framework that underpins all subsequent transactions that may occur under the contract. It defines the parties in the agreement, the possible legal implications, and the relevant legislation that can be used in case of a dispute.
Even though smart contracts are a clever piece of technology that is perfectly in line with the trustless nature of blockchain, they are not without limitations. One such limitation is that they do not have the power to resolve disputes and outside a blockchain-based system. They are not legally binding. This is where Ricardian contracts shine, as they are legally binding and can be used in court. This provides another level of security against fraudulent activities and can help legitimize blockchain technology in the eyes of regulators and governments across the world.
Blockchain technology is often seen as an uncompromising alternative to the current trust-based models and such views are entirely justified. One of blockchain and DLT's main goals is to build systems where third-party oversight is replaced by impartial network consensus governed by software code. The “code is law” mantra perfectly describes the overwhelming sentiment within the blockchain community.
However, Ricardian contracts are proof that an opportunity for intersection between both models exists. Ricardian contracts can add blockchain and smart contract functionality to standard legal agreements, which can result in enhanced transparency, reduced costs, and time optimizations when resolving a dispute. And from a blockchain perspective, the Ricardian contract offers a way for digitizing legal documents without losing any of their richness and nuance.
Despite their versatility, Ricardian contracts are not going to be the optimal solution for each scenario. If the automation of a system, for example, is the primary objective, traditional smart contracts will likely be the better option. But if you want to access the benefits of both the traditional and the trustless, blockchain-based model, Ricardian contracts might just be the thing you need. In this way, Ricardian contracts have the potential to considerably broaden the range of possible blockchain applications.
