Smart Contracts are a major tool that enables blockchain to achieve their enormous potential. There is no widely-acceptable definition currently in place. A very useful working definition for smart contracts is provided by the International Organization for Standardization (ISO). Another useful definition reads as follows: “Smart Contracts are computer programs that automatically execute instructions triggered by external events. Smart Contracts are not smart and cannot be considered as legal contracts”.
Essentially, smart contracts are computer programs/codes that contain conditions, which once triggered, automatically execute. Smart Contracts run in Dapps on DLT, such as blockchain.
Smart Contracts, operating on blockchain, benefit from all the positive features of blockchain that I have explained earlier. Further, smart contracts present noteworthy potential for efficiency gains through their automated functioning.
Smart Contracts are not contracts in the legal sense despite their name. To be legal contracts they must possess all these elements that the contract law recognizes as constitutive and essential to the formation of a contract. Smart Contracts are flexible and may either accompany a written agreement or constitute the whole of parties’ oral agreement and mutual understanding or mirror a written agreement. At the moment it is by the principles of the existing contract law that we will assess whether smart contracts are indeed contracts.
Imagine that, two parties have a mutual understanding, an agreement. The terms are coded and the smart contract that has been created is placed on blockchain. When a specified event occurs then the smart contract is triggered and self-executed in an automated way.
Smart contracts substantiate much of blockchain’s potential. They are very promising. However, they do raise important legal challenges that merit our careful examination.
Smart Contracts pose a legal challenge in and of themselves, owing to their special nature. As I explained, the terms of parties’ agreement need to be included in the smart contract code. We need to ensure that the recording of the code is made in an accurate way, because we need to transfer the parties’ exact intention and agreement into smart contracts. Because of their automatic execution, a mistake or defect in the way smart contracts are recorded will bring about results not intended by the parties. In reality, it is quite challenging to code written contract terms with accuracy and precision. Not all terms that we ordinarily find in traditional contracts are capable of being recorded or may be easily recorded in smart contracts. For example, it is hard, if not impossible, to code subjective terms like “within reasonable time”, “best efforts”, and “good faith” that we encounter very often in contractual relations. Also, force majeure clauses may also be difficult to code. Force majeure clauses provide for the termination of a contract in case of natural disaster, or other disasters. Not all disasters can be anticipated and thus coded at the time of preparing a smart contract.
The legal enforceability of smart contracts is a legal issue to further consider. Legal enforceability exists where smart contracts are legal contracts. Smart contracts are examined by reference to traditional contract law principles. However, their automated execution and unique mode of operation challenge the traditional contract law concepts and principles. It is questionable whether the conventional contract law doctrine suffices to examine smart contracts. Certain enforcement mechanisms used in contract law might also be difficult to apply. Where a smart contract is considered illegal for whatever reason, then there must be a legal possibility to reverse the performance of smart contracts. This might be challenging considering that smart contracts are automatic and contain immutable data.
Another important legal challenge is the issue of jurisdiction. Blockchain nodes, i.e. network participants are located in every part of the world, where different jurisdictional regimes apply. In case no specific provision or regard is given to the issue of jurisdiction then the blockchain database would need to be designed in a way that is compliant with all the jurisdictions involved. This could be impossible where jurisdictions conflict. Even if it was possible then this would still be extremely difficult, especially in case of permissionless databases, where access is not limited to specified groups of people. Also, this would be extremely costly, which would negate the efficiency potential of blockchain.
Dispute resolution is another relevant legal consideration, which relates to the issue of jurisdiction. Disputes might arise in the context of blockchain and smart contracts. Settling these disputes might be harder than what it seems. Traditional dispute resolution mechanisms, such as courts might have difficulty in resolving disputes, because of the sophisticated and unique technology-related issues involved. The fact that courts cannot draw from dispute resolution methods that are used in cases of previous technologies makes their task even harder.
Liability. The issue of defects in blockchain system raises further legal considerations. If there are defects in a blockchain database, or in a smart contract, then where would liability rest and which remedies would be available to address this liability? Would the “managers” of the blockchain system be liable or the coders?
The case is especially problematic where there is a permissionless blockchain, where control on the blockchain’s operation and functioning does not rest with one particular operator.
Legal Status of Distributed Autonomous Organization (DOA).
It is possible that a whole blockchain database operates without any human involvement. Could these databases be regarded as legal entities? There is uncertainty as to their legal nature but their legal nature needs to be clarified because it would determine issues like their ownership, their control, and their capacity to contract with other entities. We need to ensure that these databases are effectively monitored, regardless if there is no human involvement.
Compliance with Data Protection – “right of erasure”, article 17.
Another important legal issue that is identified within the context of blockchain is compliance with the existing regulatory framework. A significant example is the difficulty in complying with the right to erasure, as provided in the General Data Protection Regulation (GDPR), which is the relevant EU-wide Data protection regulation. Individuals may, according to GDPR, compel the processors of their personal data to erase these data. It is hard to see how this provision can be enforced in the context of blockchain where data are permanently stored in blocks.
In conclusion, the existing legal framework is inadequate and would definitely need to be revised in the light of the specific characteristics of blockchain and smart contracts.