Blockchain and smart contracts - dispute resolution challenges

Emma Stevens, Associate Solicitor - Dispute Resolution, Coffin Mew, explains what smart contracts are, how they can benefit organisations, and how the law is set to change

A smart contract is a self-executing contract. Computer scientist Nick Szabo famously described a smart contract as "a set of promises, specified in digital form, including protocols within which the parties perform on these promises" (Smart Contracts: Building Blocks for Digital Markets, 1996).

He uses the example of a drinks vending machine to demonstrate how they work:

A buyer pays money in to the machine and an irrevocable action is put in motion - the drink is supplied, and the money is retained by the machine. The transaction cannot be halted in the middle of the process. The terms of the transaction are encoded within the machine so that the contract is fulfilled technologically.

This new technology is made possible by blockchain, also known as Distributed Ledger Technology (DLT). Blockchain is a completely digitalised record-keeping system which is maintained and updated by a network of participating computers (known as ‘nodes'). Smart contract data and the entire history of transactions is encrypted on a shared ledger, which is transparent and irreversible. Once entered, data recorded in blockchains cannot be easily erased or rewritten.

Benefits of smart contracts:
The first is certainty. The conditions, performance and outcome of a smart contract need to be clearly identified to be configured in computer code to produce an expected output, so there is no chance of misinterpretation or ambiguity.

Next comes speed as execution of smart contracts is close to instantaneous, removing the prospect of delay caused by human input.

Cost is also a major benefit. The automatic execution of commercial transactions cuts out intermediaries, so that the costs associated with performance of the contract can be significantly reduced.

Finally, a smart contract facilitated by blockchain technology is visible to all users of that blockchain network and transactions are traceable and backed up, creating an irrefutable electronic trail. The decentralised database is encrypted and keeps documents and confidential information safe and secure.

Potential areas for smart contracts:
There are many potential areas which may benefit from enhanced efficiency by using smart contracts. These include automated payment systems in the financial sector, issuing and transferring securities, property transactions and land registration, transfer of funds / assets in specified circumstances and payment of insurance claims.

Dispute risks:
While the use of smart contracts to execute legal agreements is expected to increase efficiency in business transactions, their characteristics carry a number of risks:

• Security - while blockchain technology is hailed as being ultra-safe, no digitalised system is 100% protected from cyber attacks. Most famously, the DAO smart contract was hacked in 2016 when a hacker exploited a loophole in the coding which allowed him to steal $70 million.
• Performance issues - coding errors or bugs within the code may cause unexpected performance issues.
• Reliant on data input - despite the name, smart contracts are unintelligent and depend wholly on the data input they receive, meaning there is room for human error.
• Irrevocability - while the irreversible data trail associated with blockchain transactions is cited as an advantage of smart contracts, it may cause difficulties where the parties need to amend the contract or where a party is entitled to unwind a transaction.
• Drafting implications - wording in smart contracts will necessarily be certain and unambiguous, in contrast with traditional legal contracts which use context-specific performance indicators such as "reasonably". Smart contracts cannot therefore determine whether a condition has been reasonably met.
• Data protection - under GDPR an individual has a right to request that certain personal data is erased in certain circumstances and to have data corrected. The permanence of records on blockchain poses a problem to this.
  Dispute resolution challenges
  The development of smart contracts also has significant implications for traditional dispute resolution methods.

For example, regulation is complicated due to the cross-border nature of smart contracts as they may be facilitated by computers located in different countries. Determining the governing law and jurisdiction applicable to the contract may therefore be problematic.

Another challenge is that smart contracts can be executed pseudonymously which may cause difficulty with identifying someone to bring a claim against as. In cases of loss caused by coding errors or bugs, it may be tricky to prove who is responsible.

Also, disputes may be of a very technical nature, for example where a code does not operate as planned, requiring an adjudicator with some level of technical knowledge or input from an expert.

Finally, given that smart contracts operate entirely technologically, traditional dispute resolution methods may no longer be appropriate. It seems to follow that smart contracts require specialised digital redress mechanisms, which has led to the introduction of blockchain based smart arbitration.

Smart contracts and the law - the future:
Smart contract technology is full of potential and its continued development is certainly one to watch, however it is still very early days. As it stands, there is no legal framework specifically applicable to blockchain and smart contracts and it is yet to be seen how existing contract law will adapt in the coming years.

Prompted by the increased press coverage of smart contracts and their legal implications, the Law Commission is conducting a review of the current English legal framework as it applies to smart contracts.

The project will consider whether ‘the law is sufficiently certain and flexible to apply in a global, digital context and to highlight any topics which lack clarity or certainty'. The review is due to commence imminently and is expected to run for 9 to 18 months. We will be watching this space.

Emma Stevens, Associate Solicitor - Dispute Resolution, Coffin Mew