Law on the Blockchain: Part I
By Ajay Sabharwal
Introduction & Background
On 4th March 2020, a Three-Judge Bench of the Supreme Court of India delivered its judgment in Internet and Mobile Association of India v. Reserve Bank of India (“the Crypto case”) [2020 SCC OnLine SC 275] wherein it struck down a circular by the RBI placing a blanket ban on banking services to exchanges dealing in ‘virtual currencies’.
On 23rd March 2020, the Supreme Court of India, in light of COVID-19, held hearings via video conferencing for the first time ever. On 3rd April 2020, the Chairperson of the Supreme Court E-Committee, Justice DY Chandrachud interacted with the Chairpersons of the Computer Committees of High Courts, who agreed with his suggestion that the use of technology must be institutionalized even after lock down. On 6th April 2020, a bench comprising Chief Justice S A Bobde, Justices D Y Chandrachud and L Nageswara Rao passed various directions in a suo moto case pertaining to guidelines for the functioning of courts via video conferencing during the COVID-19 lock down. The bench also stressed the need for utilizing viable technology options and for them to continue post the lock down. The Chief Justice suggested that Indian courts have been proactive in harnessing technology. The Attorney General, Mr. KK Venugopal, too stressed the importance of utilization of novel technologies and for their use to continue post the the lock down.
These recent developments on the administrative and the judicial side of the Apex Court are indicative of an accepting attitude towards emergence of new technologies and their utilization in the legal system. Even though they were the video conferencing was necessitated due to the urgent need for social distancing (see: mother of invention), it would be a welcome step for the courts to use novel technology in organising the legal system and thereby, making it more efficient.
In light of these developments, two short papers on the overlap of blockchain technology and the law will be presented. This first paper will deal with how utilization of blockchain and smart contracts can make the legal system more efficient and transparent. The second paper will present a legal and economic defense for smart contracts and cryptocurrencies.
How does the tech work?
This paper presumes preliminary knowledge regarding blockchain technology and smart contracts. Though, it will not get into the detailed technicalities of the same, an attempt is made to explain the functioning of the technology in simple layman terms.
For functional purposes, in a blockchain each block contains a hash (a mathematical algorithm) of the previous block and each such block has its hash contained in the succeeding block. This forms a chain of blocks which is intended to prevent any modification or tempering of the original entries as the hash of every preceding block (since the inception of the blockchain) is encrypted onto every succeeding block. On a rudimentary level, to take up the currency example, one may assume a currency note which is handed over from A to B and when B passes it on to C, the currency note has embedded on itself the record of the first transaction A → B. This and the B→ C transaction, along with subsequent ones will be on record on the note, if and when it passes from one individual to another. Smart contracts build up on a blockchain by using software codes to automate the transaction to a large extent by setting conditions for such transfers. For example, while Bitcoin, which has blockchain as its underlying technology would function as a currency wherein the simple transaction can be read as A→B, Ethereum, the platform running smart contracts, could automate the transaction as A→B if x > 2 or if y < 4, where x or y could be the respective balance or hours completed at work or number of rice bags supplied. Let us look at a specific, more detailed example. A real estate developer is requesting funds from a number of homebuyers to carry out a project, at the end of which they will receive their respective houses. At the initial stage, the homebuyers will make a payment of a small amount and thereafter the builder will utilise this to say, lay the foundation of the building. Subsequent payments, over a period of time would continue from the side of the homebuyers and the builder would carry on the task of the contructing the building. A practical problem in a situation such as this which has been observed over the last few years, at least India is the builder not constructing even after receiving the funds (or diverting them to another project). Using smart contracts will help reduce such a problem. If the parties enter into a carefully coded smart contract, the disbursement of funds to the builder, though aligned with a certain timeline in a non-digital contract, could be aligned with the continuation of the construction work. To get more specific, if Rs. 1,00,000 is transferred each on Day 1 and on Day 31 and 61, the payments may be directly transferred to the builder till such point, when they remain in escrow within the smart contract. Now, if the code is more detailed, the flow of funds could be linked to the performance of a part of the contract, say construction of a part of the building, and how this could be easily achieved is by assessing the quantum of funds available with the builder herein. As his balances would decrease, and the need for additional funds may arise, smart contracts would be executed at the specific levels and funds would be sent to the builder from what the buyers had already paid. Needless to say, for expenditures to be tracked, a public blockchain would be recommended, but that is a larger policy problem, part of which is dealt with below. Moving to another common example of how smart contracts are used, one can take up crowd funding. In this process, an individual or groups starting a project, may reveal details about it and request for funds from the public at large. Platforms that provide such a service, usually place a condition that funds will be sent to the project developer if they meet a certain criterion, i.e. a threshold of funds raised from the public. In the instance that a certain level is not met, funds are supposed to be sent back to the parties sending the money. Placing such a transaction on a a smart contract would mean that the fund sent from the public would be kept in an escrow with the coding that if the balance levels exceed the minimum requirement, the funds would be automatically disbursed to the project developer, whereas, if for the given duration, such limit is not met, the funds would automatically revert to the senders, without a need to rely on a third party.
Thus, a transaction on a smart contract, reduces the need to trust the other transacting party. As long as a variable can be encoded correctly onto the smart contract, the transaction will be secure. The transfer happens at the completion of a said task, which can be construed as the execution of a contract. Thus, a smart contract is essentially a digital contract that provides the optionality to its users for it execution to be automated, on the completion of certain encoding predefined tasks.
Needless to add, blockchain technology and smart contracts can and have been spurring innovation in businesses and governance across the world. The legal system too, could gain extensively from its timely adoption. Apart from reducing pendency, transparency and accuracy could be increased, fraudulent behavior could be kept in check and gaming the system, too could be reduced.
How can the law benefit from it?
The rule of law is intended to reduce arbitrariness and deceit to the largest possible extent. The application of smart contracts and block chain technology will serve the purpose of reducing the scope of arbitrariness.
Enforcement of Contracts
It is trite cannon that contracts make law for themselves. In essence, after entering into a contract, parties are supposed to be bound by the terms they accept. The scope for interference and intervention by the legislature or courts is supposed to be negligible however many commercial contracts end up in courts or before arbitrators. One of the key reasons for the volume of such litigation, is shoddy drafting of contracts. A clearly worded and well defined contract is more far less likely to result in a commercial dispute requiring a lengthy adjudication.
With the usage of smart contracts encoding variables such as quantities, pricing, timing and flow of funds, performance of contracts would be made far more efficient and hassle free from the transacting parties. Thus, the implementation of smart contracts will reduce the need for litigation, especially for issues such as execution of contracts, which will in turn also reduce costs to a large extent. A fair bit of automation will also decrease the effort required for legal preparation and increased accessibility to such technologies will increase the efficiency of the legal profession due to network effects.
Property Law
Immovable property transactions, involving a significant amount of risk, require significant caution, and hence are more often than not, tedious. This is due to the complex nature of the transaction, which also gives birth to ample opportunity for length litigation. Reduction of such risk, may be accomplished by automating the process, which admittedly depends on the input being correct but once that is accomplished, any other scope of human intervention is greatly reduced.
How is this made possible? While most lease deeds have a single generational transfer, i.e. from lessor to lessee, and after the term duration, the possession reverts back to the lessor, title deeds trace the record of ownership as far back as the first owner/sanction by a government authority. The authenticity or correctness of such data, tracing back the title to the original owner is what creates trust in the system. A single incorrect entry, whether fraudulent or negligent, has the potential to dismember not just the trust equation but the deal involving the transfer of property, itself. While bona fide mistakes attributable to incompetence of the drafter might not be fraudulent, mala fide treatment of such title deeds poses a great risk to the legal and economic system. Thus, home buyers or commercial investors seek certainty of authenticity in a transaction involving huge sums of money, especially for immovable property, since it is mostly of a more permanent nature. Application of blockchain will help not merely the real estate industry but also ease the burden of any field that has some dependence on land. Most importantly, the procedure for the execution of inheritances and wills can be simplified to a large extent.
To avoid title disputes or textbook cases of title fraud, the title history must be accurate and not susceptible to modification as an afterthought. Thus, placing the records of the transfers onto a blockchain will secure the transaction from external interference and reduce, if not remove the possibility of fraud in transfers of immovable property. Whether or not, there is mala fide intent, such an application is bound to reduce property disputes by eliminating arbitrariness in the process. However, any output is only as good as the input and the effectiveness of such a system, like any other, will depend on the accuracy of the information that is put into the system to begin with. However, initial supervision may be necessary to ensure truthfulness in the input stage of the substance in question.
Furthermore, utilization of a smart contract to execute the sale deed, would streamline the process and remove dependency on external actors or requirement of trust on the transacting party. More often than not, there is a significant cash component involved in any sale of immovable property. While the primary intent may be to avoid the resulting tax burden, this often leads to some optionality for defrauding the other transacting parties. An immediate/instantaneous transfer through the execution of a smart contract would remove such negative optionality. As the funds would be sent from the purchasing party and would be secure as a part of the smart contract, the seller would have the assurance of the funds and would not have received them either till the fulfillment of his part of the deal. Furthermore, if such a system is decentralized in an accessible manner, it could also reduce the dependency on middlemen or an additional escrow service provider, thus reducing the overall cost of transactions.
From the point of view of the registry, the publication of land records and title deeds onto a blockchain is not only going to increase transparency but also help deal with outdated cases. While digitization of records is the need of the hour and is taking place, a mere replication from handwritten or typed copies to scanned or soft copies is not going to remove loopholes and uncertainty within the system. Attempting to locate details of any old case would be a more fruitful exercise if the mechanism involved helps trace the details of a given piece of land and those adjacent to it, given that a certain area has its own records on a single blockchain.
Case Law Management
One of the most effective ways in which blockchain technology can help improve the bar and the bench, is by incorporating case laws onto a blockchain. One chain may deal with a certain question of law and branches of the same may overlap and connect with those of another. Building up on the same blockchain, would help add much needed clarity in identification of updated and overruled judgements. For example, the chain dealing with the question of appointment of judges of High Courts and the Supreme Court, would have as its first block SP Gupta’s case, which would be followed by SCAORA [I], followed by the Special Reference, which in turn would have as its final block (yet) the NJAC case [SCAORA II]. While this seems a nominal exercise with not much impact, given the limited number of cases and the mainstream knowledge of such a topic, the importance and effectiveness of such an application would be seen as complexity increases. Add to this chain, the landmark decision in L. Chandra Kumar, followed by the Madras Bar Association cases and one would be able to compile a larger chain of cases dealing with appointment of judges to tribunals as well as the constitution of such tribunals. Adding other related cases to such a setup would highlight the overlap of different questions of law and while on the initial level this may seem a rudimentary exercise, incorporation of the wide body of case laws since the days of the Privy Council having the final say in India, uptill the latest cases being taken up today, would highlight the benefit of such an exercise.
While it is certain that some Senior advocates and judges, owing to their eidetic memories, might not find much use for such an application, it would still be of assistance to the younger lawyers. To know how the law has been progressing, with realtime updates would be of some assistance to such judges who have been assigned a roster wherein they do not have any prior experience. More importantly, it is the lower judiciary that is most likely to better its working from the use of such an apparatus. Updating the law on a day to day basis on a public blockchain accessible by all lawyers and judges alike, will remove scope of arbitrariness or crafty reading of the law before a court, which may not be the intended interpretation by a higher court.
As an example, in a bail matter with a charge of s. 409 of the Indian Penal Code for “Criminal breach of trust by public servant, or by banker, merchant or agent” the order granting bail cited a case law wherein the particulars of the section were broken down into parts. While public servant, banker and merchant were highlighted, the excerpt did not include the phrase ‘agent’ in the bail order. On closer and full examination (by the author herein) of the specific case law cited, it was revealed that the original case law indeed mentioned the phrase ‘agent’ along with the others. While the exclusion of an ‘agent’ in the reading of the law was the sole reason recorded for grant of bail in the said case, it is as likely that in another case with similar facts, involving a similar question of law, before the same or another judge, the outcome would be different.
Whether the aforementioned situation is attributable to an unethical move on the part of the lawyer or an error on the part of the judge, is not the question at hand. The idea is to reduce the possibility of such an occurrence by reducing the scope for misinterpretation of the law, whether due to ignorance or malice. Thus, apart from making judicial application easier for the higher and lower judiciary, clarity in the law is maintained. Akin to the point made above regarding property law, the input stage may require supervision and may have to be verified, (presumably by a committee of judges) to ensure accuracy. With or without initiation from the bench, law reporters such as SCC, AIR and Manupatra should make the first move as they are best suited to implement such an idea and take it to the largest possible number of people.
Intellectual Property Rights
Incorporation of blockchain technology in supply chain logistics is bound to be among the most significant developments in recent times to combat counterfeiting. As physical goods are placed on the blockchain (via product tagging) and as the utilisation is made easier for customers on different levels of the supply chain, checking counterfeiting will become much easier. Companies across the world spend millions of dollars to carry out physical checks and searches to combat counterfeiting. Introduction and application of blockchain technology will help protect intellectual property rights. Since, a given product, say a luxury leather wallet, would be encoded onto the blockchain, its authenticity may be verified on each level of the production process as well as the wholesale and supply process. Needless to say, such a process would be most helpful to the end consumer who would be assured of the authenticity of the product, he/she is purchasing.
As a prevalent example, the Vechain Ecosystem, built on top of the VeChainThor public blockchain by the VeChain Foundation, provides such solutions to businesses across the world, especially in the luxury sector. More recently, it was used in verifying the authenticity of N-95 masks to avoid COVID-19. As supply chain logistics become more secure, the possibility of interference, and thereby of counterfeiting is reduced significantly. Utilization of blockchain technology is an effective way of strengthening the ISO/IEC global standards to combat counterfeiting, especially ISO 12931 and ISO 17367 which deal with performance criteria for authentication solutions and product tagging respectively.
Registration of patents and designs could also gain efficacy by introduction of blockchain by the respective registries. The process would help in avoidance of duplication and introduction of alterations. The grant of protection to updated designs would be made simpler and with higher accuracy, which in turn would save court time and litigation costs.
Banking & Insurance Law
The legal components of the financial sector would gain from the utilization of these new technologies the same as contract enforcement. As smart contracts would enforce direct instantaneous transfer of funds, either from the lender or as repayment from the borrower, the requirement of legal preparation for execution would be reduced. Similarly, under insurance law, each case could be handled in a fashion whereby the need for additional paperwork, to and fro filing would be avoided greatly. Once the smart contract is designed as per the agreement between the insuring party and the insured, the fulfilment of the criterion, as may be required for the execution of the contract would lead to an instant immediate transfer. While a simpliciter approach seems more inclined towards the consumer, detailing in the coding of the contract would balance the pooling of risk.
Governance, Privacy & Data Protection
Any quasi-judicial body or government department that requires filing of some kind would improve its working by implementing a public blockchain of its own and by having the regulated entities showcase a direct stream of revenue in real time. This would directly increase transparency and innovation, while saving time and resources across departments, including but not limited to company law matters, tax matters and mergers and acquisitions. Processes such as filling of RTI applications, which have a two-way communications system would also be made faster and more efficient by utilization of both a public blockchain as well execution of smart contracts. Transparency in government expenditures can be increased by tracking flow of funds from one department to another or to external contractors.
As put forth in earlier paper for the Agenda by Sodaksh Khullar, titled, ‘Aadhar on Blockchain’, placing the Aadhar unique identification system onto a public blockchain based verification system will ensure security and transparency of the citizen’s data. It would allow the encrypted identities to be verified, without leaving the biometric data vulnerable, thus reducing privacy concerns as each individual would be able to take control of their own data. A digital time-stamped trail will allow the citizens to audit the various parties that have been accessing their data ensuring transparency and trust.Whatever monetization of the data may take place may be by the direct consent of the owner of such information who may use it the way he/she wishes. Blockchain solutions would also reduce data inaccuracies, improving interoperability of various enterprise applications with the unique ID system. Furthermore, such an application would add to the security of the entire government records system as no single point of attack would be able to bring the system down.
Coda
Even though courts are opening up to the utilization of some new technologies during the lockdown, two points need to be kept in mind. Firstly that there should be continuation of such usage of new technologies after the lockdown and secondly, that such reforms should lead to incorporation of other new technologies in the legal system, which may not appear essential at the current stage. Blockchain and smart contracts are two such recent innovations that can assist the judicial system and the legal profession in increasing accuracy and transparency while reducing time, effort and costs and the potential for the technologies goes beyond the areas mentioned in this paper. The omissions in this paper also include the areas in which smart contracts and blockchain may require additional work. Technology, after all, has the power to exaggerate the flaws as much as the merits of humanity. While the demerits of the technologies in question may be left for another time, it remains essential that supervision, especially at the initial stages of the input of data is not done away with.
Successive judges and law ministers have claimed that it is their intention to reform the legal system and reduce pendency of litigation. While procedural reforms require a ton of political will from the executive and the judiciary, carrying out reforms to implement new technologies, is a simpler if not necessarily a methodical way of bettering the legal system.
About the Author/Biases
The author is the President of the Indian Youth Economic Association and a student at the Faculty of Law, Delhi University. For full disclosure, he owns a small portfolio of cryptocurrencies including Bitcoin, Ethereum and Vechain.
