DOCTRINAL CHALLENGES FOR THE LEGALITY OF SMART CONTRACTS: LEX CRYPTOGRAPHIA OR A NEW, 'SMART' WAY TO CONTRACT?

AuthorAgnikhotram, Sai
  1. Introduction

    Compared to the internet, blockchain is at its early stages but the contemporary relevance of blockchain technology (1) is gaining more and more space in the public discourse. Some argue that blockchain is a "paradigm shifter" (2), a next internet age--an "internet of value" (3)--that will change society. Without doubt, while in 2009, blockchain's acclaim emerged mysteriously when the anonymous, Nakamoto, published his seminal paper outlining bitcoin--a virtual currency, (4) nowadays, fast forward ten years, and this currency's $200 billion (5) valuation justifies the broad public resonance it now receives. For all its worth, bitcoin proves the capacity of blockchain but many other--arguably more significant--applications are constrained by the uncertainty created due to a lack of regulatory guidance. Smart contracts are one of such disruptive but hindered applications.

    Szabo, the 'theorist' of smart contracts, defined this technology as: "a set of promises, specified in digital form, including protocols within which the parties perform on the other promises". (6) To date, scholars have no consensus on the 'right' definition of smart contracts. (7) What remains uncontested throughout the scholarly discourse reviewed by this work: this new way of organizing private relationships, closely resembles and conflicts with traditional contracts. (8) Recent blockchain innovations bring this technology within the reach of possibility. (9)

    Smart contracts already have the potential for binding digital agreements in code and automating performance by leveraging blockchain technology (10). Today, companies like Monax (11) are creating smart contract templates to democratize this technology for the greater public. Slock.it (12) and Etherparty (13) are automating micro payments for the sharing economy. Overall, there are more than 15 types of transactions which smart contracts can improve--across industries. (14)

    These applications are not just the aspirations of startups. Within the public law sphere, consider for example how the Estonian government aims to create a digital government; facilitated and secured by smart contracts. (15) Even the most established and regulated industries leverage smart contracts: the international Swaps and Derivatives Association (iSDA) is developing a smart contract standard which will ensure fluidity and safety of financial transactions. (16) These, and many other applications, could only be possible if the law recognizes their legality.

    While commercial adoption is rising, and industry players wait for regulatory actions, the ecosystem is struggling to answer: are smart contracts legal? (17) Do we need a new body of law, the so called Lex Cryptographia to justify their legality? (18) Or smart contracts are simply a new, 'smart' way to contract that will progressively be regulated by the traditional framework of private law?

    Blockchain's potential and legality is perceived with great trepidation and uncertainty. in the public sphere, many conclude that the lack of a comprehensive regulatory approach is a major issue for further propagation of this technology. in disarray, the likes of Cermeno (19) and Dong He (20) call for an open discussions and collaborative stakeholder agreements. While the European Banking Institute (21), the European Parliamentary Service (22) and United Kingdom's Chief Scientist (23), expound unassailable risks, the Securities and Exchange Commission (24) in accord with the commodity Futures Trading commission (25) take firm but conflicting stances. In summary, institutions and regulators, as pointed out by Perugini and Checco, are focusing on deterring risks while taking a "wait-and-see" approach when considering policy stances. (26) While possibly good for innovation, 'waiting and seeing', leaves a legal gap and increases uncertainty for market actors. The private space, however, applauds blockchain smart contracts with great excitement. Norton Rose Fulbright in collaboration with one of the most prolific banking consortiums, R3, spear-heads the hypothesis that legality is conceivable. (27) Baker McKenzie (28) and Clyde & Co (29) take a partial validity stance; explaining specific forms of legality. Similarly, Hogan Lovells (30) and Linklaters (31) find creative workarounds for using existing doctrine for new use cases. Yet, it is not clear how these approaches are advanced. Positioning oneself as a legal expert can attract clients but proposed solutions may not stand in a court of law if there are no legal sources to rely on. Above all, these works intuit that solutions are available but may require doctrinal reconciliation.

    That said, some theorize that a corresponding law will emerge organically--a self-regulation. De Filippi (32), Raskin (33), and Werbach (34)--to name a few--believe that the emergence of a new set of rules--Lex Cryptographia--will displace private law. (35) 'Lex Cryptographia' alludes to the Lex Mercatoria: "a set of general principles and customary rules spontaneously referred to or elaborated [...] without reference to a particular national system of law". (36) In this way, blockchain enthusiasts compare themselves, as Hatzimhail comments, to a "community of international merchants, who were cosmopolitan--probably in spirit and certainly in their needs". (37)

    This comparison begs to consider: could market actions of smart contract enthusiasts pave the path to smart contract legality? This proposition is, on the one hand, contestable, and on the other, a feasible reality. Thus, this paper aims to address: do we really need a Lex Cryptographia to ensure the legality of smart contracts?

    1. Defining Smart Contracts

      1. A Primer on Blockchain Technology

        To explain practical and legal applications of this technology we need to rely on some technical discourse. Like Werbach, let us consider 3 functional--architectural elements of blockchain. (38) Blockchain is a network (39) which as Nakamoto notes, is "robust in its unstructured simplicity". (40) This network is 'robust' because it allows users to manage online interactions without a central authority--it is decentralized--ensuring the integrity of data exchange. A number of distributed computers are connected to this network via software. Data flows from computer to computer simultaneously; each computer maintains a record of all transactions.

        Blockchain is also the architecture of an information system with a set of rules--also known as a protocol--for data exchange. As Halpern and Pass explain:

        At the heart of the distributed ledger technology is a blockchain protocol, a protocol for achieving consensus on a public ledger that records bitcoin transactions. To the extent that a blockchain protocol is used for applications such as contract signing and making certain transactions[.] (41) Each computer connected to this information system, algorithmically solves a computer programing problem known as the Byzantine Generals. (42) By solving this problem the computer "[...] establishes the truth of an event without recourse to a trusted third party [...]". (43) This type of validation allows parties to agree on a single version of truth--about the data--that is stored, secured and is verifiable by other users. In a simplified sense, the blockchain is a database of transactions organized in smaller data sets--"blocks". (44)

        Continuing the database analogy, the blockchain is an immutable public ledger. Each block containing information about transactions is created in a chronological manner: "linked to each-other (like a chain) in a linear, chronological order [...]" keeping and updating this 'chain' every 10 minutes. (45) This sequential organization explains the name 'block'-'chain'. The effect: an identical record that is shared amongst all users; much like an open, public ledger where data cannot be changed or altered once it is recorded on the blockchain--it is immutable. (46)

      2. A Primer on Smart Contracts

        i. A Formal Definition of Smart Contracts--Lexicological Priorities

        There is "[...] no agreed upon definition for smart contract[s...] [compared to other blockchain concepts] this creates the greatest confusion and an incomparable level of disagreement for regulators [...]". (47) Competing technical and legal interpretations create diverging effects. Walch recognizes this issue as a "challeng[ing] unstable verbal terrain [...] for regulators [...] in how they understand, discuss and ultimately regulate (or not) the technology and its uses". (48) Thus, this work supplements the lack of a formal definition with common characteristics. (49)

        Recognizing the 'definition problem', Amuial considers three functional elements that concretize this concept. (50) Element one, relates to a transaction that is evidenced and stored on the blockchain; while supposing more than merely a transfer of virtual currencies. The second element requires that this is a single or multi-party transaction. The final element requires that the performance of the transaction is autonomous, requiring little human input after the contractual formation--the 'smart' nature of the contract.

        Proposed by notable scholars within A Guide for Legal and Business Professionals and accepted by many lawyers, the above definition misses the true purpose of a smart contracts. (51) Szabo was the first to theorize smart contracts in 1994, when he defines them as: "[a] set of promises, specified in digital form including protocols within which the parties perform on the other promises automatically". (52) The adoption of this definition has two principal effects: 1) this definition implies a legal characteristic, created by promissory obligations--"promises"; and 2) said obligations are ensured by automatic performance--"automatically". The refined definition elucidates a legal dimension and the automation mechanism--characteristics necessary for the discussion on smart contract legality. Nonetheless, this concept...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT