Law Quarterly

Get Smart, Contracts?

By Mathew Anekstein

Apr
04

Technological innovations that are commonly discussed and theorized are often met with diatribes concerning the loss of jobs following their implementation, or prophecies likened to the Terminator series, but rarely are seemingly more innocuous ideas given the air-time they should. In the past few months, Wall Street has become enamored of cryptocurrencies such as Bitcoin and Ethereum, which have become practically ubiquitous terms. However, the concept (Blockchain) underlying these cryptocurrencies is less commonly understood, with its possible applications unbeknownst to most. With Blockchain’s possibilities expanding seemingly every day, and novel ideas for its application to various industries, it should come as no surprise that even the law is expected to be affected by it. But before the aforementioned fears begin developing in your mind, it must be clarified that this discussion will focus on Blockchain’s ability to revolutionize contracts.

These so-called “Smart Contracts” utilize software to automatically process payments and verify the rendering of services or transfer of ownership—all under the scrutiny of the public through Blockchain.[1] Blockchain, at its most basic definition, is a public ledger of activities and transactions.[2] In short, contracts utilizing this technology would allow participants to easily prove the existence of its content in a time-stamped segment of the Blockchain. Overall, this technology would allow for greater ease in upholding contracts and the terms within them.

However, along with this come potential drawbacks—the most glaring of which being that the technology, at least in the foreseeable future, would likely only be applicable to simpler agreements. While repetitive, this idea would likely revolutionize basic transactions, which would allow for increased ease in the creation of simple and secure contracts. However, those involving many conditions may not be affected. For example, in a contract establishing very specific terms, each only satisfied under a plethora of conditions, it would be extremely difficult for the Blockchain to adjust and keep track of all, let alone ensure that they are satisfied. Furthermore, since some contractual issues may be bound by common law established decades ago, and the complicated nature of contract law itself, lawyers should not expect to be replaced just yet. Exemplifying the limitations of Blockchain in contracts, the Decentralized Autonomous Agency (DAO), a crowd-funded venture capital firm, recently lost approximately 50 million dollars when the mechanisms underlying its crowdfunding software were hacked.[3] While the Blockchain itself was not the target of the attack, the smart contract which utilized it was. The code allowing transactions to occur within the contract was flawed, enabling hackers to steal money from the organization without violating the rules contained within it. As the hack was permitted by the code, it was deemed a legitimate action by officials. This controversial conclusion establishes an inherent drawback of this technology. Since there are no laws that permit the analysis of the intent of code when a smart contract is seemingly breached (as is done for typical contracts), what is written is what stands.[4]

The issue described above relates to a smart contract featuring its code as the sole purveyor of its terms. However, practical solutions do exist, as depicted by a white paper published and produced by Norton Rose Fulbright. While the firm noted the value of Blockchain coupled with a smart contract, especially in the financial sector, it also stressed the importance of listing the following within its code: specific contractual terms, differentiated contracts for each transaction within a multi-step operation, enforceability provisions, and dispute resolution mechanisms.[5] Ultimately, because smart contracts are snippets of code both defined and enforced by blockchain, they are incapable of accounting for unforeseeable circumstances (which typical contracts utilize vague wording to compensate for), and cannot replace legal language.[6]

Before considering whether a contract can be enforced, one must first determine if it is even binding. For this reason, one can determine that most smart contracts, as they exist today, may not meet the requirements necessary to be considered contracts. If the smart contract does not outline the consideration (the tangible goods or services rendered) underlying the transaction, the parties involved instead consent to a program (that outlines the steps taken to monitor the process) rather than the transaction process itself. If the smart contract includes a clause specifying the exact consideration each party will provide in the transaction, the issue can be resolved, and the contract becomes much more likely to be enforced.[7]

Issues of jurisdiction and dispute resolution further complicate smart contract enforceability. As the smart contract would exist on the internet, with the parties potentially across the globe from each other, and an uncertain number of individuals validating the transactions established by it, a lawsuit could take place anywhere on Earth. If a location is determined, the dispute would be regulated by the laws relevant to the location decided, providing even further difficulty in enforcing the terms of the agreement. The solution to these problems would thus be forum selection clauses (specifically stating the jurisdiction where any disputes would be resolved) and a dispute resolution clause (if the parties would prefer not to be bound by the courts and instead opt for an independent arbitrator).[8]

In conclusion, the jury has not even arrived yet in determining the degree to which Blockchain is applicable to contract law. Some believe it can revolutionize the field, while others are dubious of whether its value outweighs its risk. Regardless, Blockchain is a concept that will remain in the public’s attention for quite a while. The only question now is whether the legal world is prepared for it.

Bibliography

  1. Jacobson, Gregg M. “Op Ed: Three Legal Pitfalls to Avoid in Blockchain Smart Contracts.” Bitcoin Magazine. November 1, 2017. Accessed March 8, 2018. https://bitcoinmagazine.com/articles/op-ed-three-legal-pitfalls-avoid-blockchain-smart-contracts/

  2. Juetten, Mary. “Legal Technology and Smart Contracts: Blockchain & Smart Contracts (Part IV).” Forbes. September 06, 2017. Accessed March 08, 2018. https://www.forbes.com/sites/maryjuetten/2017/09/06/legal-technology-and-smart-contracts-blockchain-smart-contracts-part-iv/#1e43e53e6a5f.

  3. Popper, Nathaniel. “A Hacking of More Than $50 Million Dashes Hopes in the World of Virtual Currency.” The New York Times. June 17, 2016. Accessed March 8, 2018. https://www.nytimes.com/2016/06/18/business/dealbook/hacker-may-have-removed-more-than-50-million-from-experimental-cybercurrency-project.html?_r=0.

  4. Kostakis, Vasilis, Primavera De Filippi, and Wolfgang Drechsler. “Can blockchain, a swiftly evolving technology, be controlled?” The Conversation. May 03, 2017. Accessed March 08, 2018. https://theconversation.com/can-blockchain-a-swiftly-evolving-technology-be-controlled-73471.

  5. Murphy, Sean, and Charley Cooper. “Can smart contracts be legally binding contracts? An R3 and Norton Rose Fulbright White Paper, Key Findings.” November 2016. Accessed March 8, 2018. http://www.nortonrosefulbright.com/files/norton-rose-fulbright–r3-smart-contracts-white-paper-key-findings-nov-2016-144554.pdf.

  6. Kostakis, Vasilis, Primavera De Filippi, and Wolfgang Drechsler. “Can blockchain, a swiftly evolving technology, be controlled?” The Conversation. May 03, 2017. Accessed March 08, 2018. https://theconversation.com/can-blockchain-a-swiftly-evolving-technology-be-controlled-73471.

  7. Jacobson, Gregg M. “Op Ed: Three Legal Pitfalls to Avoid in Blockchain Smart Contracts.” Bitcoin Magazine. November 1, 2017. Accessed March 8, 2018. https://bitcoinmagazine.com/articles/op-ed-three-legal-pitfalls-avoid-blockchain-smart-contracts/

  8. Ibid.

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