Benjamin Bestgen: Smart contracts

Benjamin Bestgen

Benjamin Bestgen gives readers an overview of smart contracts this week. See his last jurisprudential primer here.

Part of being a lawyer in the 21st century is the necessity to develop a degree of digital literacy, whether you like it or not. The legal world, it is often said, tends to be conservative and cautious. Assuming for argument’s sake this is true, conservatism, broadly speaking, looks at things that work well for us and seeks to preserve them while also doing away with things that are no longer fit for purpose. If something has to change, reform and incremental steps are preferred over revolution and big overhauls.

Conservatives in that sense are reasonable, practical people, willing to look at facts and evidence, notice changes in the ways of the world and decide how and where adaptations should be made. This could also mean learning new skills or languages, embracing new technologies, reforming rules, customs and institutions to meet the needs of the times and ideally anticipate future requirements also.

Unfortunately, for most humans, their conservatism is not as enlightened and proactive. We are creatures of habit, including habits of thought and attitude. We get used to certain things, learn to operate and like them and get irritated when somebody tries to foist too much change on us too quickly. How many lawyers had to be dragged kicking and screaming from using scriveners and parchment to typewriters, dictaphones, fax machines, computers, emails, online data-rooms, electronic signatures, marking documents up on screen instead of printing them out, using multiple screens instead of one, smartphones, videoconferences, mobile or online banking?

And now stuff like the Internet of Things, blockchains, Fintech/Regtech/Insurtech, data mining, data protection, AI and customer service bots, debates about robot judges… But contracts – they surely stay the same?! Yes and no is the unsatisfactory short answer…

Smart Contracts

A contract is a document ideally drafted by a smart lawyer but a Smart Contract is more likely to have been programmed by a software engineer: it is a piece of code – contractual clauses, functions, outcomes, deadlines, trigger events can all be codified on a blockchain. Execution, monitoring and enforcement are automatic, giving certainty that the agreement will be performed, not deadlines missed, no random changes of mind later on. The cryptographic, decentralised and open nature of blockchain reduces or eliminates the need for intermediaries or third parties in transactions. It increases trust, as all parties have the same code on their computers and the blockchain is transparent.

What to consider

From a lawyer’s perspective, the principles of contract law haven’t changed, regardless whether a contract is oral, on paper or in code. But there are issues to think about:

1. Natural language: few people, never mind lawyers, can read or write machine code languages. Machine code may also not be readily translatable into natural language. Therefore it can be unclear what exactly the contract meant to say. 

2. Limitations of code: writing code requires mathematical precision so the machine knows exactly when to do what. But contracts contain often deliberate ambiguity, such as “best efforts”, “good faith” or “to such an extent as reasonably practicable”. The law may also require that certain things are clearly disclosed or registered in a contract before execution (e.g. consumer protection and cancellation rights or matters in real estate) – this may not be possible to do in code.

3. Amendments and variations: blockchain is highly tamper-proof and once a contract is on the blockchain, it cannot be changed. This poses difficulties where parties want to correct errors or make modifications to their arrangement. A self-executing Smart Contract can also not be stopped, so there could be issues when trying to comply with a court order to amend a contract or change its performance.

4. Risks of self-execution: a contract that no longer reflects the transactional reality in which the parties operate doesn’t just give rise to disputes, it might also cause harm to the parties, suppliers, customers or other stakeholders directly or indirectly affected by it. Contracts like “futures” trading in natural resources, e.g. coffee, textiles, grain, fruit or vegetables can affect people in entire countries. The inflexibility of Smart Contracts combined with their self-executing nature is arguably an example where technology could do more harm than good.

5. Jurisdiction: Unless a jurisdiction expressly doesn’t recognise Smart Contracts as valid legal agreements, there is no reason why a contract written in cryptographic code shouldn’t be lawful and enforceable. But the cross-border nature of blockchain makes it harder to pin down which jurisdiction should address disputes. This gets more complicated with possible errors in the code or the operating system, and relevant servers potentially located in jurisdictions who have no real connection to the contracting parties.

6. Identity of parties: Smart Contracts can easily be executed pseudonymously. This could provide cover for crime and all kinds of misbehaviour. Service providers called “Oracles” exist which offer to provide additional verification and comfort to blockchain arrangements. However, Oracles, both human and automated ones, can be compromised too and introduce misinformation into the network, amplifying a risk of error and malfeasance which the decentralised nature of blockchain sought to reduce.

Smart Contracts currently appears best suited to matters which can be programmed with great precision, such as a payment or delivery schedule, transfer of digital assets, changes in registers upon certain events or storage of information. It should have a natural language document alongside it, detailing how the agreement is meant to work and prevailing over the Smart Contract in case of doubt.

However, advances in technology and how we do business will require a basic philosophical attitude from lawyers: looking at our world and trying to make sense of it in a sound, forward-thinking manner, whether we personally approve of the latest developments or not.

Benjamin Bestgen is a solicitor and notary public (qualified in Scotland). He also holds a Master of Arts degree in philosophy and tutored in practical philosophy and jurisprudence at the Goethe Universität Frankfurt am Main and the University of Edinburgh.

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