In this article, Nritika Sangwan pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on Arbitration and Blockchains.
Smart Contracts and the Blockchain technology that they use are the focus points in almost every industry. With changing times and fast-growing technology, contracts are no longer executed in person. They are executed online by parties who reside overseas.
Smart Contracts
Before moving on to the understanding of Blockchain Arbitration, it is imperative to understand what smart contracts are and how they work. Smart contracts were first proposed by Nick Szabo, who coined the term, in 1994[1]. Smart Contracts can be defined as a set of promises, specified in the digital form, including the protocols within which the parties comply with these promises[2].Therefore, a smart contract is a computer protocol that digitally facilitates, verifies and enforces the execution of a contract[3]. Smart contracts are irrevocable and irreversible.
Illustration:[4] A vending machine that dispenses snacks, drinks, etc. is an example that incorporates the features of smart contracts. Once the money is inserted into the machine, an irreversible action begins. The money is retained and the snacks are then vended. Such a transaction cannot be revoked or terminated while the process of going on. Therefore, it follows, that the terms that govern and operate the machine are incorporated into the hardware and software of the machine.
Basic Features of a Smart Contract
- Digital: They are in a computer format – code, data and operating programs.
- Embedded: Contractual clauses are embedded in the software in the form of computer code.
- Technology-mediated Performance: Payment release and other actions are enabled by technology-based functions and rules.
- Irrevocable: once started, the result for which the smart contract is encoded cannot usually be terminated (unless the result depends on an unsatisfied condition).
Businesses and financial institutions are developing a wide range of uses, like the issuance and transfer of securities, clearing the derivatives, the tracking of the ownership of goods for commercial financial transactions, the arbitrage of the consumption of energy to the verification of the identity of the passengers and ticketing.
Smart contracts are on a spectrum
- A contract can completely be written in code.
- A hybrid or divided model, for example, a coded contract that incorporates by reference the terms of a natural language master agreement.
- A natural language contract with coded performance, like the payment mechanism.
- A coded contract with a separate language version.
Today’s smart contracts are implemented on platforms based on so-called distributed accounting technology (DLT) or, often, the blockchain. DLT and blockchain allow parties (eg, peers, banks, regulators and/or listeners) to reach a consensus on a set of shared facts. In simpler words, a blockchain works as follows:
- The exact copies of an accounting database are shared between communities of participating computers. These are known as nodes.
- When a party wishes to execute or register a new transaction, a request is sent to the network, where the nodes receive it for processing.
- A consensus algorithm, an administrator, or a subgroup of participants determines the authenticity of the received request.
- If it is authentic, the ledger automatically gets updated with new “blocks” of data.
Some DLT platforms can run programs on each of the network nodes that use the general ledger data. Smart contracts are implemented with the help of these programs. For example, a blockchain can register ownership of a digital currency, and a smart contract can include a code that automatically transfers an amount of that digital currency to another account on the blockchain when a particular event occurs. ,
Conflicts because of Smart Contracts[5]
Many technologists believe that smart contracts will replace the law of contracts and the courts. There exists a misconception that since the Smart Contracts are executed automatically and their performance cannot be terminated, they eliminate the risk of conflict. This is nothing but an illusion. While smart contracts offer huge benefits in terms of reduced transaction costs and increased security, conflicts may still arise. In fact, the intersection of contract law and the code creates potential areas of conflict. Certain potential areas of conflict are discussed as follows:
- In many Common Law countries, a contract can only be valid if it is carried out by a legal entity (i.e. a natural or legal person such as a corporation). There is also a Common Law Authority (for example, under English law) that a contract cannot be concluded without reasonable certainty about the nature of the contracting parties. Some civil laws set further legal requirements for the formation of a legally binding contract.
- Coding errors can lead to unexpected performance problems.
- There may be inconsistencies in the natural language version and coding of a Smart Contract.
- The parties may wish to repudiate a Smart contract for breach of or delineate it on grounds of mistake, misrepresentation or coercion.
- Subsequent changes to laws or regulations (such as sanctions) may make the smart contract unlawful.
- Smart contracts can work on the basis of inaccurate data flow.
Incapacity of Conventional Courts to try matters relating to Smart Contracts[6]
As the number of online transactions increases, the need for more conflict resolution agencies that can handle cases that arise from this new and unconventional relationship also increases. An answer to the question of whether it is reasonable to introduce new forms of dispute settlement is necessary for the following reasons:
- Some technologies appear and disappear faster than the required laws. Therefore, it makes no sense to use an agency to resolve a dispute in this area for which there is no relevant legislation.
- The conventional legal system with courts that are already stalled cannot meet the needs of a rapidly evolving technology. Imagine the case where you enter into a smart contract with your foreign partner that completely replaces a traditional escrow. Of course, a fight can happen. Conventional courts will have difficulty defining the nature of their transaction since it is limited to the statutory definition of escrow. It’s no hidden fact that reality can go beyond legal thinking.
Need for an Arbitration Clause[7]
It is extremely essential to include an arbitration clause in the Smart Contracts as they give rise to a number of dispute resolution challenges. Some reasons for the same have been mentioned below:
Difficulty in filing a lawsuit
It is very easy to enter into a Smart Contract pseudonymously. In such cases, it is difficult to identify the person against whom the claim should be made. It is also difficult to determine who is responsible for the loss caused by operating system errors, corrupted messages or broken codes.
Uncertainty about jurisdiction and applicable law
Smart contracts operate through distributed nodes. These nodes can be based anywhere around the world. Therefore, it becomes difficult to determine the applicable law and jurisdiction; it also increases the risk of satellite conflicts over these issues.
Problems in enforcement
A key feature of a Smart Contract, and what is usually seen as an advantage, is that they cannot be revoked and that the transaction is permanently inscribed in the blockchain. However, this creates problems when a party has the right to terminate or revoke a transaction. Arbitration is going to be the preferred mode of resolving smart contract disputes for several reasons, and litigation for smart contracts, in turn, will spur innovation in arbitration.
Protection of patented information
Certain Smart Contract disputes may include evidence of proprietary software and proprietary hardware. In cases where the source code and other confidential information when made public may have important commercial ramifications for any of the parties, it is preferable to accept confidential arbitration as the means for dispute resolution.
Need for Blockchain Arbitration[8]
- It is a known fact that we all move the e-universe in one way or another. There is no denying that the digital world is changing faster than the analog world. And for one reason or another, disputes arising from electronic commerce are rarely taken into account in conventional public courts.
- In fact, there are strong reasons why courts will not address the challenges of resolving conflicts with new technologies. The reasons for it have been discussed above.
- More effective approaches to conflict management must be developed. Traditionally, arbitration has been considered the most effective way to solve problems related to business, but its capacity may be insufficient to resolve average transactions quickly and economically. This is where the blockchain should come into play.
- The potential uses of blockchain technology can go beyond mere currency, as they can give new impetus to the development of new dispute resolution methods. For example, smart contracts can guarantee an unprecedented level of decentralization, which operates autonomously without the use of intermediaries.
- The combination of two, blockchain-based dispute resolution and smart contracts, has the potential to bring the quality and applicability of conflict resolution to a new level. The good news is that it finds a wide application in real products, which aim to exploit the full potential of Blockchain. Among several applications of this type, special attention must be paid to Confideal.
- Confideal provides an integrated environment for the creation of legally binding, secure and encrypted contracts, which will be executed automatically at the specified time.
- The platform offers a wide range of tools to write and manage smart Ethereum contracts without any programming or legal requirements. With the built-in arbitration module, users can solve any problem without having to resort to intermediaries or reveal personal information.
- It is like a traditional litigation, but without procedural obstacles, where you can file a complaint, choose your judge and manage your procedure by simply pressing a button on your computer.
Conclusion
The time has come for the online community to create new ways of dealing with disputes arising out of Smart Contracts. The resolution of conflicts with the use of blockchain is no longer an option. It is an imperative. In the realities of life, it is the only way to configure the blockchain solution to obtain wide recognition and acceptance. It is clear that in the early stages of massive implementation of such solutions, including smart contracts, some problems may arise. An automated, reliable and cost-effective dispute resolution system will be essential to maintain consumer confidence in such applications.
References
[1] Nick Szabo, (1996). Smart Contracts: Building Blocks for Digital Markets
[2] Nick Szabo, (1996). Smart Contracts: Building Blocks for Digital Markets
[3] Smart Contracts. (2018, February 3). Retrieved from
https://en.wikipedia.org/wiki/Smart_contract
[4]Arbitrating Smart Contract disputes. ( 2017, October). Retrieved from http://www.nortonrosefulbright.com/knowledge/publications/157162/arbitrating-smart-contract-disputes
[5]Arbitrating Smart Contract disputes. ( 2017, October). Retrieved from http://www.nortonrosefulbright.com/knowledge/publications/157162/arbitrating-smart-contract-disputes
[6]Arbitrating Smart Contract disputes. ( 2017, October). Retrieved from http://www.nortonrosefulbright.com/knowledge/publications/157162/arbitrating-smart-contract-disputes
[7] Arbitrating Smart Contract disputes. ( 2017, October). Retrieved from http://www.nortonrosefulbright.com/knowledge/publications/157162/arbitrating-smart-contract-disputes
[8]Why is blockchain-based Arbitration the only future for dispute resolution? ( 2017, October 5). Retrieved from
