A short overview of Smart Contracts and the Law

There has been substantial legal discourse around the topic of smart contracts versus legal contracts. This is an aggregation of the existing academic literature on the topic, particularly in relation to the following key questions:

1. What are smart contracts?

2. What are the limitations of smart contracts?

3. Are smart contracts legally binding contracts?

4. How are cross-border smart contracts disputes adjudicated?

Special thanks to Guang-Yi, Legal Counsel at the Ethereum Foundation, for feedback and review. All views expressed are mine.

I. What are smart contracts?

Computer scientist and polymath Nick Szabo, who coined the term “smart contract”, defined it as a “computerised transaction protocol that executes the terms of a contract”. Smart contracts are deemed “smart” because they are arguably more functional than traditional legal contracts. However, this does not mean that these contracts are smart enough to replace traditional contracts, even if they exist and function on a blockchain.

A blockchain-based smart contract is a protocol encoded on a blockchain that automatically executes a predetermined set of actions once a set of conditions is fulfilled. In a way, traditional contractual clauses in the form “if X then Y” can be translated into programming languages (code) and embedded into smart contracts that can enforce them automatically. This automatic function of smart contracts minimises the need for trusted intermediaries between parties (e.g. procurement officials, institutions, or legal experts).

II. What are the limitations of smart contracts?

Smart contracts are unable to make decisions that require subjective assessment. For instance, it is difficult to imagine how a smart contract would determine whether one party has discharged its obligation to carry out “commercially reasonable endeavours” or to take “reasonable care”. While oracles may feed the smart contract with information external to the blockchain, this is not a satisfactory solution given that oracles are incapable of making these subjective assessments either. Ultimately, a venue or channel for dispute resolution is still required for subjective determinations or value judgements relating to the terms of a contract.

III. Are smart contracts legally binding contracts?

A “smart contract” is not necessarily a validly enforceable legal contract. Just as different jurisdictions have different requirements for what constitutes a validly enforceable legal contract, the same applies to smart contracts. For now, the traditional requirements for a legally binding contract are still what governs whether a smart contract will be valid in a court of law. For example, under the common law, three elements need to be fulfilled before a smart contract is considered legally enforceable: (a) the transaction must involve an exchange of promises made with an intention to create legal relations; (b) transaction is supported by consideration; (c) formality requirements in some cases. Some academics posit that the problem with smart contracts lies mainly with the fulfilment of formality requirements. For example, some contracts are required to be in writing and signed by the parties. The question is then whether a smart contract written in code and signed by the parties’ digital signatures suffices.

IV. How are cross-border smart contract disputes adjudicated?

Besides the legal validity of smart contracts, of interest to people who use smart contracts would be whether any dispute that arises in relation to their smart contract activities could be adjudicated by their local courts. This is especially where the opposing party to a smart contract-related dispute is usually a pseudonymous or anonymous individual from a different jurisdiction. After all, one of the core value propositions of a blockchain is to allow individuals to transact pseudonymously and permissionlessly across borders.

The pseudonymity or anonymity of the opposing party is no barrier to the formal adjudication of a dispute in court proceedings. For instance, in the UK, in AA v Persons Unknown [2019] EWHC 3556 (Comm), the court granted a proprietary injunction over bitcoin which was paid as ransom payment in circumstances where the defendant was an unknown person. Similarly, in Singapore, in CLM v CLN [2022] SGHC 46, which concerned the theft of cryptocurrency assets, the SGHC held that there is nothing in our Rules of Court 2021 that requires that a defendant be specifically named. Thus, it held that the Singapore courts have jurisdiction to grant interim orders against anonymous defendants.

With regards to the cross-border aspect of smart contract disputes, there appears to be two ways to approach this.

On one hand, such disputes might involve a conflict of laws issue where the courts have to decide whether they are the appropriate forum to hear the case. For instance, in a Singapore case — Janesh s/o Rajkumar v Unknown Person (“CHEFPIERRE”) [2022] SGHC 264, the court was faced with the issue of whether it was the appropriate forum to hear a case concerning a plaintiff’s stolen NFT in circumstances where this occurred through the defendant triggering the smart contract between them. The court ultimately held that sufficient nexus with Singapore was established given that the plaintiff was in Singapore and conducted his business in Singapore.

On the other hand, some academics have opined that such disputes can be resolved “on the blockchain” without recourse to the courts. An example would be through online dispute resolution platforms like Kleros which embed oracles into smart contracts. In such instances, should parties disagree on the fulfillment of a certain obligation, the parties can trigger the oracle and a decision on this dispute can be made by Kleros’ jurors. Maxime Chevalier has even opined that there is no need at all for the court’s interference and instead a “blockchain arbitral legal order” should emerge.

V. Conclusion

Legal discourse on smart contracts and their analogy to traditional legal contracts have been substantial. For now, there is something to be said for the view that smart contracts are neither smart nor contracts; they are unable to encode more than straightforward “if X then Y” logic and there usually is no counter-party to a smart contract.