Blockchain law — DLT Smart Contracts
Smart contract use grew rapidly in recent years as everyone, from governments to private enterprises, actively participate in the global race toward innovation.
The market for self-enforcing smart contracts has been projected to grow 32 percent annually in the six years ending 2023, during which it is expected to reach about $300 million in value. This increase from various governments’ perceived need to adapt with the times; growing market competition exists in both the domestic and international fronts, compelling expansion through mergers and acquisitions, boosting research and development investments, finding them the most cost-efficient business structure, among other strategies.
We see in several sectors the development of smart contracts in tandem with other technologies, say, artificial intelligence and cloud storage, among others, with the aim at optimizing the efficiencies offered by these technologies.
The potential of smart contracts increases when questions of its legal effectivity arise, the technology being a “contract”, after all.
To understand the impact, it’s necessary to know first how smart contracts work.
A. What are smart contracts?
Smart contracts are computer-facilitated transactions with instructions conveyed in the form of a programming language instead of human language. The instructions automate the execution of a transaction that is laid down in the contract once the computer detects that predetermined conditions required for the transaction’s enforcement are fulfilled.
This process essentially makes “smart contract” a misnomer as it does not fit in the legal sense that anyone unfamiliar with the technology would have surmised the term was meant for.
While the term emerged as early as 1994, its real-world-use was only realized recently thanks to the creation of blockchain where these codes are found viable for storing.
A blockchain is a type of distributed ledger technology which allows the creation of a network across which data can be shared and audited. Thus, with blockchain, smart contracts can be distributed to a network enjoined by selected contracting parties via their computers.
It is worthy to note that although Ethereum was the first to launch smart contracts in a blockchain platform, several others that allow the layering of these into their own have emerged as well.
B. How does it work?
As smart contracts cover transactions involving almost anything of value —money, assets, insurance policy, etc.— an offer, to be mapped out in code script, should first be laid down. Parties will have to determine what kind of smart contract is most viable for their preferred arrangement.
The use of smart contracts can be two-pronged:
- Internal — here, the code stipulates the terms for all processes involved in a commercial or contractual transaction — from payment obligations, confidentiality, executions, etc. — making up the entirety of the contract.
2. External — the code oversees only a certain number of obligations under the parties’ agreement.
When parties have agreed on the type of smart contract to govern their deal, the acceptance of the “offer” would require the sending of a digital signature. Where will this be sent? To the smart contract’s address code which is stored in the computer of the other miner or miners who will be part of the network. Once received, the transaction will be stored in the blockchain and can be run by those who are entrusted with copies of the smart contract.
C. What are the benefits?
A study by the Accenture titled “Technology Vision 2018” showed that 60 percent of 6,300 executive-respondents from 25 countries believe that that blockchain and smart contracts will be critical to their organizations in the next three years.
Hence, as the number of corporate partnerships has soared to unprecedented levels, businesses feel that these ventures, as part of expansion strategies, will be stronger established if founded on technological platforms like smart contracts.
Smart contracts have been gaining favour because of its several proven benefits that many bank on as improving the business scene to the advantage of both service provider and consumer.
Here are a few main reasons why:
- Transparency — the decentralized architecture of the blockchain where smart contracts are stored enables trusted parties in a network to view the contract
2. Auditability — the difficulty in changing or terminating a smart contract is an attractive feature for many; it allows no room for manipulation of data, making parties confident that
3. Lower cost — smart contracts eradicate the need for several intermediaries except for an oracle which is a party outside the consensus arrangement. Because blockchains cannot source information from outside the network, the oracle provides the information that will help determine if conditions are met to execute a transaction. Other cost reductions are in monitoring of whether commitments and obligations are being fulfilled since terms are executed automatically as well as in paper fees
4. Fast — due to automation, smart contracts can perform multiple tasks in a matter of seconds
D. What are the disadvantages?
1. Lack of flexibility of coded terms — earlier, it was mentioned that the irreversibility is a benefit for most. However, the feature is a double-edged sword; it can be a blessing and a curse. To note, parties cannot add a term with the that has one meaning at the time of execution and can be interpreted differently during the performance phase. This makes it difficult to make alterations once the code is in operational phase. Similarly, when an electronic contract is contrary to an existing or new law or to the interest of consumers, a party can, in many jurisdictions like in Spain, petition a court to stop the contract’s automatic performance.
2. Limitations and complexity of scripting language — words like “good faith”, “force majeure” or “good judgment” are some examples of abstract concepts that can also set subjective standards in an agreement, meaning allow flexibility for instance, parties wavering a term under the smart contract. Unfortunately, experts have noted that the programming language is limited and cannot translate some legal concepts, especially those abstract in nature, into code. Besides the constraints of a limited coding vocabulary, consumers unfamiliar to code scripts may be compromised, somehow diminishing the purposive design of smart contracts to be transparent.
3. Present lack of court guidance to resolve issues that may arise from smart contracts — although contract breaches may be said to be impossible in smart contracts, disputes may still arise on the back of varying interpretations between contracting parties. If such issue is elevated courts, there are many questions that expose the limitations of the court in judicially enforcing a contract. Some questions may include:
· Does the court have jurisdiction over the case as far as assets, parties, and the platform per se is concerned?
· What law will govern in resolving the parties’ dispute when contracting parties are based in different states or countries? Or should judgment be based on where the contract was deployed? If the latter, which part of the contracting process should be identified the point of deployment?
· A plaintiff’s remedy may be limited to monetary compensation/damages. However, how would a court enforce a monetary damage award against far-flung, potentially anonymous entities?
E. How does a smart contract fit into the legal system and are they legally binding?
In the legal field, there are several areas where smart contracts can operate: contract law; license management; dispute settlement; corporate law; regulatory concerns and data privacy issues.
Not only does it bring about efficiencies in matters of contract formation. Akin to other technologies, smart contracts are perceived as challenging the law’s scope and capacity to recognize modern tools that it could claim to be under its power. From this, several questions arise: are these new tools and systems making long-existent laws irrelevant in the application of a technological world? Does the growing adoption of smart contracts signal a nearing end to the traditional methods of forming contracts? Can they be a cheaper alternative to lawyers who charge exorbitant?
Another major question that may trigger some confusion is whether smart contracts are legally binding.
As mentioned earlier, smart contracts do not in itself effectuate a legal obligation. However, these can be a valid mechanism to make agreements legally-binding. But the discretion of its enforceability varies from one country to another depending on whether their laws recognize an electronic signature, a key part to the deployment of a smart contract, as a valid legal instrument.
The United Kingdom, for instance, adopts a requirement of certain documents to be in writing and signed, as stipulated in its 1677 Statute of Frauds. This is incompatible with the more recent statute, the Electronic Communications Act 2000, which adopts the admissibility provision in the European Union’s (EU) Electronic Identification and Trust Services Regulation (eIDAS).
The eIDAS sets out rules for electronic transactions. It also recognizes an electronic signature as admissible in the EU-state courts and not having less of a legal effect compared to a handwritten signature.
The UK Law Commission admits that the two regulations makes for a gray area in the treatment of electronic signatures, thus, discouraging businesses — -especially smaller businesses and start-ups which have limited financial resources for legal consultancy services — to fully go digital which is the easier and faster path of doing business.
To put an end to the confusion, the UK Law Commission announced in August last year that the electronic signature is valid valid and will generally meet the statutory requirements where there is an intention to authenticate the document.
Although laws on electronic signatures differ from one jurisdiction to another, it is still well-advised that those involved in smart contracts ensure that conflicts will not stem from the deployment of the terms as smart contracts may be categorized as information-technology based messages like e-mail. Several jurisdictions already acknowledge contracts transmitted via e-mail as legally binding.
F. Who are using them?
Of the top 10 Ethereum smart contracts with the biggest transactions, bulk or 40% were initial coin offerings. This was followed by centralized exchanges, decentralized exchanges and collectible tokens, respectively.
The graph shows that usage of smart contracts in the Ethereum, the dominant platform for the technology, remains concentrated in the exchange of Ethereum-based tokens and creating ERC-20 and ERC-721 tokens.
This means smart contracts designed for non-crypto related may still not be mainstream. However, non-cypto users of smart contracts are beginning to increase, ranging from startups, non-profit organization and multinational firms like Deloitte, AXA and Cisco, among others.
Aside from the private sector and non-profit groups, several governments have begun mulling over the role that technology can play in improving governance as well.
A 2015 report by the UK’s Office of Sciences had cited some case uses in the UK government where blockchain and smart contracts can make an impact:
1. protecting critical infrastructure against cyber attacks;
2. reducing operational costs and tracking eligibility for welfare support, while offering greater financial inclusion;
3. transparency and traceability of how aid money is spent;
4. creating opportunities for economic growth;
5. bolstering SMEs and increasing employment;
6. moreover, reducing tax fraud
G. What’s in store for the technology in the future?
Although there has been this preconceived idea that smart contracts will replace lawyers, the spike of smart contracts showed the contrary; the technology is creating greater demand for consultancy services to ensure that the formation of smart contracts remains within legal confines.
However, as smart contracts become complex, lawyers are expected to cope with these complexities by better understanding how blockchain and smart contracts work vis-à-vis the real world and the risks that come along.
Moreover, although most can agree that current guidelines remain limited in fully accommodating the existence of technologies like these, the law, in stark contrast to smart contracts, is dynamic. Measures and efforts remain ongoing to make clear and resolve regulatory concerns revolving around smart contracts. Legislators may eventually pass new laws to oversee their increasing use and complexity.
Even as much of these efforts may still be in the dark as to what they will be, it is certain that the public and private sectors, as they have been doing since time immemorial, will jointly strive to craft regulations to adapt with the evolution of technologies like smart contracts.
