The Role of Law in Regulating Smart Contracts

INTRODUCTION


Globalization has led to trade between countries in different time and space. This makes it imperative for commercial contracts between parties to bring the business to futility. Block chain technology has played an important role in ensuring that contractual agreements are made, despite border barriers between countries. One of the forms in which block chain technology has played a role in contractual agreements, is through the use of smart contracts. Smart contracts are computer codes that can automatically monitor, execute and enforce a legal agreement.1 Smart contracts can reduce the time lawyers spend on drafting documents.2 As smart as these contracts might be, it is important that laws are put in place to regulate how these contracts are used. Hence, this essay will examine the role of law in regulating smart contracts.

Part I will look at the enforceability of smart contracts; Part II will provide the advantages and legal challenges of smart contracts, while Part III would examine the role of lawyers in smart contracts.

PART I

THE ENFORCEABILITY OF SMART CONTRACTS


Smart contracts are not necessarily legal contracts. To create a legally enforceable contract under U.K law, two or more parties must generally demonstrate that an offer was made and accepted through a “meeting of the minds” and accompanied by an exchange of consideration.3

1)Offer:

In smart contracts, code deployed on a distributed ledger would likely constitute an offer, if other participants on the ledger are entitled to interact with and execute on the code. 4 By way of example, in the well-established context of algorithmic trading, parties use computerized algorithms as negotiators before a contract is formed, allowing the parties to choose the order terms to offer to the market.5 Further, in some distributed ledger systems, a party can send the terms of a proposed smart contract to another party, constituting an offer solely to the receiving party.6

2) Acceptance:

Acceptance can be made either by formal acceptance such as, by signature, or by completing performance pursuant to terms of the offer.7 In either case, acceptance requires both an agreement. In smart contracts, this is simply posted on a public ledger and any participant in the ledger may indicate acceptance through signing the transaction with a private key.8 Deploying a smart contract to a distributed ledger and signing the smart contract with a private key should constitute a valid offer and acceptance.

3) Consideration:

Here, the exchanged promises must be “bargained for.”9 This means each party must provide some form of consideration to the other. In smart contracts, a type of value must be exchanged.10 Value can be given now or in the future and a promise to perform in the future constitutes valid consideration. The value given in terms of smart contracts could be in form of crypto currencies.

From the above, it is clear that smart contracts are capable, in principle, of forming binding contracts which will be upheld under English law.

PART II

KEY ADVANTAGES OF THE SMART CONTRACT


1) The speed of automated performance and reduced costs associated with the time required to draft and negotiate contracts: Smart contracts can be generated automatically via a platform, according to a predetermined pattern and syntax, thereby negating the need to craft a contract from scratch.11 Such automation represents a tremendous increase in transactional efficiency, potentially applicable to many routine legal documents that could be created with minimal to no human involvement.12

2) The ability to encode regulatory and other compliance logic into the platform. Such coding would be likely to reduce, or even eliminate high costs, delays, and errors that demand personal handling or reworking in the context of highly-regulated industries, such as the financial industry or securities sector. For example, as a result of their immutability feature, block chain-based smart contracts maintain a record of compliance-related steps and processes required by regulatory agencies, which will lead to more efficiency.

However, smart contracts are not yet capable of fully replacing traditional agreements drafted by lawyers. The inadequacy of smart contracts in legal agreements would be considered below.

THE LEGAL CHALLENGES ASSOCIATED WITH SMART CONTRACTS


1) Self-enforcing arbitration based on multi-signature addresses:

Block chain technologies in form of smart contracts, seem to have the ability to marginalize State courts by enabling the creation of self-enforcing systems of private dispute resolution. These systems can potentially bypass the recognition and enforcement procedures through which States traditionally exert control over arbitral rulings. Hence, the role of national courts may be progressively marginalized. A multi-signature address, then, allows private parties to set up a dispute resolution procedure that is effectively able to enforce its own outcomes.13

This form of adjudication based on multi-signature addresses, seems to be a unique form of transnational arbitration, operating outside of the shadow of State law with a high degree of finality and self-sufficiency. Yet, to date, very little is known about the practical reality of this procedure; the identity of the arbitrators (who are often non-lawyers), the modes in which the parties and the arbitrators interact, the evidence-taking mechanisms, and the substantive rules or principles applied to the disputes still remain a sort of terra incognita of private adjudication, where most arbitration scholars have not ventured yet.14

2) Automatic enforcement which prevents a balance between creditor and debtor rights in the context of enforcement procedures15

Most national laws seem to acknowledge the need for some kind of balancing rather than enabling creditors to obtain an immediate and entirely frictionless enforcement. Technologies such as smart contracts, by contrast, do not adhere to the same logic; the allocation of the disputed assets to the prevailing party happens instantaneously, by technological means, without the intermediation of State courts and bailiffs and, most importantly, without any kind of evaluation as to whether certain rights of the debtor should be protected.16

In smart contracts, automatic enforcement may result in the violation of the debtor's fundamental rights, and the circumvention of guarantees traditionally put in place by State law. To limit this type of risk, the law of enforcement may progressively need to become a law of software, providing bright-line criteria as to the limits within which some codes included in smart contracts should be allowed to operate.

PART III

THE ROLE OF LAWYERS IN SMART CONTRACTS


Smart contracts offer new opportunities for the legal profession. Instead of replacing written contracts, it is now common for smart contracts to operate in tandem with them. This hybrid model allows contracting parties to benefit from the legal certainty of written contracts and the efficiency of smart contracts. An example of this is Initial Coin Offerings (“ICOs”), where companies offer digital tokens for sale to the public.17 A smart contract facilitates the collection of virtual currencies and distribution of the company’s digital token, with a written agreement setting out the risks purchasers assume and the rights they have against the vendor. As a result, the advent of smart contracts has actually created demand for legal services.18

Also, regulation at the transnational level seems to be particularly desirable. In order to ensure effectiveness, while avoiding excessive restraints on technological evolution, a meaningful step could be the development of soft law guidelines, identifying a list of practices that coders should avoid.

Therefore, in order for smart contracts to be adopted, they need to be legally compliant. As a result, these projects will need the help of legally-trained professionals to ensure that the development of their smart contracts stays within regulatory confines. Some scholars have argued that lawyers need to have some coding background so as to easily interpret a smart contract, but this is still inconclusive.19

CONCLUSION


It is true that smart contracts provide various advantages which would be useful to both lawyers and clients. However, it is important that the challenges discussed above should be examined and solutions proffered. This will enable smart contracts to be legally compliant and ensure that both lawyers and clients continue to embrace the advantages that come with block chain technologies such as smart contracts.

BIBLIOGRAPHY


Amy Schmitz & Colin Rule, Online Dispute Resolution for Smart Contracts, 2019 J.

Disp. Resol. 103 (2019)

Chamber of Digital Commerce: Smart Contracts- Is the Law Ready?

Freshfields Bruckhaus Deringer: https://www.freshfields.com/en-gb/our-thinking/campaigns/digital/fintech/whats-in/whats-in-a-smart-contract/

Jiang Jiaying, The Normative Role of Smart Contracts, 15 US-CHINA L. REV. pp139- 149 (2018)

Mateja Durovic & Franciszek Lech, The Enforceability of Smart Contracts, 5 ITALIAN

L.J. 493 (2019)

Richard Susskind: The End of Lawyers? Rethinking the Nature of Legal Services, Oxford University Press 2010

Smart Contracts: a boon or bane for the legal profession? https://www.taylorvinters.com/article/smart-contracts-a-boon-or-bane-for-the-legal-profession

The impact of blockchain technologies and smart contracts on dispute resolution: arbitration and court litigation at the crossroads – Unif. L. Rev. (2019) 24(2), pp 430 at page 441

1 Freshfields Bruckhaus Deringer: https://www.freshfields.com/en-gb/our-thinking/campaigns/digital/fintech/whats-in/whats-in-a-smart-contract/

2 Richard Susskind: The End of Lawyers? Rethinking the Nature of Legal Services, Oxford University Press 2010

3 Mateja Durovic & Franciszek Lech, The Enforceability of Smart Contracts, 5 ITALIAN L.J. 493 (2019) at page 494

4 Chamber of Digital Commerce:Smart Contracts, Is the Law Ready? September 2018, page 15.

5 Ibid. page 15

6 Chamber of Digital Commerce: Smart Contracts- Is the Law Ready? page 15

7 Chamber of Digital Commerce: Smart Contracts- Is the Law Ready? page 16

8 Ibid. page 16

9 Ibid.

10 Ibid.

11 Jiang Jiaying, The Normative Role of Smart Contracts, 15 US-CHINA L. REV. pp139- 149 (2018) at page 142

12 Jiang Jiaying, The Normative Role of Smart Contracts, 15 US-CHINA L. REV. pp139- 149 (2018) at page 142

13 The impact of block chain technologies and smart contracts on dispute resolution: arbitration and court litigation at the crossroads – Unif. L. Rev. (2019) 24(2), pp 430 at 436

14 Smart Contracts: a boon or bane for the legal profession? https://www.taylorvinters.com/article/smart-contracts-a-boon-or-bane-for-the-legal-profession

15 The impact of blockchain technologies and smart contracts on dispute resolution: arbitration and court litigation at the crossroads – Unif. L. Rev. (2019) 24(2), pp 430 at page 441

16 Ibid.

17 Smart Contracts: a boon or bane for the legal profession? https://www.taylorvinters.com/article/smart-contracts-a-boon-or-bane-for-the-legal-profession

18 Ibid.

19 Amy Schmitz & Colin Rule, Online Dispute Resolution for Smart Contracts, 2019 J. Disp. Resol. 103 (2019)

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