Written by: Sakshi Jain, Student, Christ (Deemed to be University)
Smart contracts are touted for their efficiency, transparency, integrity and speed. But like all things with an uncontrolled acceleration results in a crash, so does the unregulated use of this digital boon.
Smart contracts were birthed by Nick Szabo[1] in 1994. He defined them as agreements that are enforced not by law, rather by hardware or software that would “fully embed in the property the contractual terms which deal with it.” Since then things have changed drastically.[2] What puberty does to human offsprings, blockchain technology and artificial intelligence did to smart contracts.
In an ideal world where smart contracts are the norm of the day, breach of contracts would become an alien phenomenon and this stems from the fact that smart contracts are self-automated and self-executing which means once they are wound up they will ensure the follow-through of the terms and conditions of the agreements without fail. So these contracts are irrevocable. Smart contracts ensure that the position of an intermediary to assist in the execution of the contract is void because the middleman is futile in this consumer-driven contract.[3] Thus, the only prerequisite to ensure the execution the contract is the fulfilment of the condition contained in the Code. Therefore, smart contract can be explained as if “a” condition is fulfilled, then execute “y”. Here y could very well be payment of consideration in the form of bitcoins.
Traditional concepts are based on a mutually agreed promise[4], and in smart contract this mutually agreed terms and conditions are written in Code enabling them to be digitally set in a computer system.
The Code encrypted to set in motion the execution of Smart Contracts leaves no scope for flexibility in the form of ambiguous terms which a party may construe in its favour. Even though superficially, this seems like a benefit arising from the use of smart contracts, it does sprout problems. As stated before, these contracts are irrevocable and irreversible, which leads to the need for a very well smoothed out contract which boasts of clarity and makes provisions for every fathomable scenario. Even an ounce of ambiguity could kick-start a faulty transaction which would end up negatively impacting the parties concerned. But is it possible to provide for every contingency in the code of this anticipated Smart Contract?
Another facet of the commercial world that is vehemently ignored by this Digital Era genie is the preservation of a valued relationship with a long time vendor or customer. Smart Contracts leaves no room for any real-time decisions. Traditional contracts allowed excusing a breach or waiving off a late fee when a party decided that preserving a relationship with a long-time vendor far outweighs the adverse impacts of the breach of promise.[5] Thus, Smart Contracts may not be flexible enough to incorporate the not-so-wound-up manner in which businesses operate in the real world.
Smart Contracts are on the verge of becoming vogue, and among other things it owes this to the fact that transaction costs which are usually incurred in the form of assistance to draft the traditional contracts are allegedly reduced. However, smart contracts belong to the world of artificial intelligence and blockchain technology and from this it follows that the cost has to be eventually borne on an individual who is tech-savvy and knows his way around the Code that becomes the backbone of the Contract. So, it’s just a classic case of Potayto – Potahto.
Foreseeable Legal Problems
We have looked at the loopholes that plague smart contracts from a commercial perspective, now look at it through the lens of a legal critic. The first question that can be posed is who assumes the role of a “Wrong-doer” [6]when things go south? Will it be the individual hired to program the code or will it one of the parties to the transaction? These contracts are immutable. Once the wrong Codes are entered there’s no going back from it. What happens when there is a mishap in the process of execution? These are simple questions with possibly convoluted answers. The same advantageous feature of smart contracts which is self- executing and immutability might end up being its own nemesis.
Decentralized is another key feature of smart contracts that is derived from blockchain technology. Parties to a smart contract can be located across in different jurisdictions and the fact that blockchain technology is a globalised platform; it raises the question of the governing law and jurisdiction.[7] The parties to a contract must be cautious enough to specify the venue of the contract and the law that shall be governing the nitty-gritty of the contract at play.
Contracts work on the principle of “meeting of minds” so if both parties mutually agree to a lawful object there shouldn’t be speed- breakers in their path. The next legal question that needs to be answered before we endorse Smart Contracts like common soap is what happens when the parties want to amend or change the terms of the contract after it is encoded. Do they have to write up a whole new contract? Since blockchains are immutable there will be high transaction cost in this situation.
One of the essential ingredients of a valid contract is a lawful object and this requirement can currently be undermined in Smart Contracts as there is no governing body actively watching over the transaction that is carried on this digital platform. Therefore, the various loopholes in the current mechanism of Smart Contracts makes it hard for us to give legal validity to Smart Contracts in the present day.
Conclusion
Logic, reason, conscience and discretion are the building blocks of traditional contracts. It wouldn’t be smart to indulge in smart contracts unless they become an acceptable mixture of traditional concept stripped of its disadvantages and smart contracts endowed in its benefits. But without a doubt technology and innovation will continue in its growth and may eventually lead to smart contracts being commercially adaptable and legally viable. But for that to happen smoothly there is a dire need for a governing body and a regulatory framework to fill the loopholes that persist presently in the world of blockchain technology as a whole and thus come up with solutions to the legal and commercial questions that stem from the use of Smart Contracts. Smart Contracts are not smart enough, not yet.
As Uncle Ben put it “With great power comes great responsibility”. This can, aptly, be said to be the principle that should guide the use of Smart Contracts and Blockchain Technology.
References
[1] Alok Vajpeyi, India: Smart Contracts: A Boon Or A Bane?, Mondaq, (2019), https://www.mondaq.com/india/fin-tech/870846/smart-contracts-a-boon-or-a-bane. [2] Nick Szabo, Smart Contracts: Building Blocks for Digital Market, (1996), http://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html. [3] Jonathan G. Rohr, Smart Contracts and Traditional Contract Law, or: The Law of the Vending Machine, Cleveland State Law Review, (2019), https://engagedscholarship.csuohio.edu/clevstlrev/vol67/iss1/9/. [4] Charlotte R. Young, A Lawyer's Divorce: Will Decentralized Ledgers and SmartContracts Succeed in Cutting Out the Middleman, Washington Law Review, (2018), https://openscholarship.wustl.edu/law_lawreview/vol96/iss3/5/. [5] Stuart D. Levi , An Introduction to Smart Contracts and Their Potential and Inherent Limitations, Harvard Law School Forum on Corporate Governance, (2018) https://corpgov.law.harvard.edu/2018/05/26/an-introduction-to-smart-contracts-and-their-potential-and-inherent-limitations/. [6] Jaccard, Gabriel, Smart Contracts and the Role of Law, (2018) https://ssrn.com/abstract=3099885. [7]Jens Frankenreiter, The Limits of Smart Contracts, Journal of Institutional and Theoretical Economics (2019), https://ssrn.com/abstract=3328464.
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