This article provides an analysis of Smart Contracts which operate using Blockchain technology and provide an interesting alternative to Traditional Contracts. The former dispense with the need to involve an intermediary for the purpose of enforcement, drafting and further provide for greater transparency and accountability. The latter on the other hand cannot help but mandate the need to involve an intermediary between the parties to aid them in the drafting process and enforcement process of the contract. Thus, as is evident Smart Contracts have advantages over Traditional Contracts. However, it must be borne in mind that these advantages are not without limitations of their own and have various legal issues associated with them. The authors in this article have engaged with some of these advantages and limitations and legal issues associated with Smart Contracts. In addition to this, an attempt has been made to understand the various differences between Smart Contracts and Traditional Contracts.
The term 'Smart Contracts' was first coined and defined by Nick Szabo in 1994. He defined them as "a set of promises, specified in digital form, including protocols within which the parties perform on these promises." From this simplistic definition, today we have moved onto more complex forms of Smart Contracts that operate using Blockchain technology.
The functioning of the Blockchain technology entails using a code that is encrypted on to a computer for the purposes of enforcement and execution. While transacting via Smart Contracts, parties do not require an intermediary or a middleman to provide them with assistance in execution. In order to explain Smart Contracts better we can take the example of Vending Machines. In a Vending Machine, a code is already encrypted which makes it possible to dispense with the need to involve any third person. Consequently, this makes self-execution possible. Each item inside the Vending Machine has already been designated a cost price and accordingly the Code is encrypted. It is only when the Vending Machine receives an amount corresponding to the set cost price, does it dispense the item from inside the Machine. Thus, when every condition contained in the Code has been fulfilled, the Machine moves on to the execution stage.
Thus, Smart Contracts using the Blockchain technology operate in a similar fashion just like a Vending Machine. The parties contract with each other using a mutually agreed upon Code that is digitally set in a computer. The Code consists of all the terms and conditions that have been agreed upon by the Parties, and it is only when all of these terms and conditions are fulfilled is the contract executed. These Smart Contracts can therefore, in simple words be understood as 'Consumer-driven Contracts.'
However, there is more to Blockhain technology than this. Blockchain technology can also be understood as being a 'Ledger' on which each transaction is recorded for perpetuity by way of what are called 'nodes'. The duty to record the transaction lies with the users themselves. This ledger is made publically available. Since each part of each transaction is recorded on the Blockchain, therefore it is extremely difficult for a user to unilaterally modify, amend or delete a particular transaction existing on the Blockchain without anyone else obtaining knowledge of the same. Moreover, the cost of a modification or deletion in any form would be so high, that it would simply act as a disincentive to do the same.
In a Vending Machine, once the money has been inserted into the machine, the transaction becomes irreversible. Regardless of whether the consumer wants the item anymore or not, the Machine will dispense the item that was requested for. Similarly, when individuals choose to transact by Smart Contracts as opposed to Traditional Contracts, the transaction is irrevocable. Once the Code has been digitally set into the computer, the Computer only focuses on the terms and conditions set therein. If the Code is activated, and set in motion, it will simply examine whether or not the terms and conditions are being fulfilled and execute accordingly. If they are in fact being fulfilled, the contract will be executed, and if they are not, whatever is provided for in the terms and conditions shall be executed.
The very rationale behind introducing the concept of Smart Contracts is elimination of those obstacles which hinder the path of business growth. One such obstacle is breach of Contracts and lack of enforceability or delayed enforceability by taking recourse to the various dispute resolution mechanisms. Since Smart Contracts do not require the parties to take recourse to such mechanism and instead can be executed without the need of a middleman, they prove to be an attractive alternative to Traditional Contracts.
DIFFERENCES BETWEEN TRADITIONAL CONTRACTS AND SMART CONTRACTS
There are two major differences between Traditional Forms of Contract and Smart Contracts. These differences pertain to their enforceability and flexibility. Before discussing these in greater detail, it is imperative that we first understand the meaning of Traditional Contracts.
Traditional Contracts can be defined as those Contracts which are formed by 'a fair negotiation process between parties with equal bargaining power.' Most legislations governing contract law across the globe, provide for certain characteristics that a Contract must mandatorily possess in order for it to be a legally valid contract. These characteristics differ from State to State, however there are certain shared features amongst all of them. These include communication, acceptance and consideration (anything that is considered to be valuable by the parties and the law) . In most Jurisdictions, any Agreement that lacks consideration is not considered to be valid contract.
Traditional Contracts can either be in the written form or in the electronic form. The key feature that distinguishes traditional Contracts from Smart Contracts is that they are not self-executing in nature, unlike Smart Contracts. This means that in order to enforce a Traditional Contract, a middleman (for example, a lawyer or a Court) is needed to ensure that there is no breach of Contract by either of the parties and all the terms and conditions contained in the Contract are being fulfilled. On the contrary, Smart Contracts enforce themselves as soon as all the terms and conditions are fulfilled. As a result of this self-execution, there is no need for a middleman to intervene and this in turn also substantially lowers the possibility of a breach of contract.
The relevance of Contracts and Contract law in today's era is perhaps far greater than any other subject matter of common law. Individuals enter into Contracts with other individuals, Corporations, Companies for various business purposes. All of these purposes for which parties enter into contract entail several risks. It is impossible to anticipate all the risks that are associated with any business or with a dispute of any kind. This gives rise to the problem of ignorance of risks involved, which can be cured through Contingent Contracts. Contingent Contracts are a component of Traditional Contracts.
Contingent Contracts can be defined as those Contracts that are executed only if an event which is collateral to the Contract either takes place or does not take place (depending upon the Contract.) Considering that Smart Contracts are digital in nature and self-executing, it can be logically deduced that they demand a certain degree of cohesiveness and clarity about the terms and conditions. Unlike in a Traditional Contract, in a Smart Contract there is no room for ambiguity or issues pertaining to interpretation of terms. This is because the Code is encrypted in a computer, which uses Artificial Intelligence (AI) to enforce the Contract. The parties need to ensure that the Code is well defined, as it is an irreversible transaction. Any ambiguity or flaw in the Code could possibly result in a faulty transaction, which might affect the parties adversely. Moreover, it is not feasible to incorporate in the Code of the proposed Smart Contract more than a few contingencies for the execution of the Contract, as this could also lead to a faulty transaction.
In a Traditional Contract, there is greater scope for flexibility because the parties can choose to incorporate as many contingencies as they wish. Of course this does come with problems of its own, but the risks of incorporating several contingencies are more in Smart Contracts because there is no middleman to assist the parties in that situation. Furthermore, it is pertinent to mention that the language used in a Traditional Contract is far broader and nuanced than the language of a Code to be encrypted in a Computer.
Keeping these differences between Traditional Contracts and Smart Contracts in mind, the authors would in the next section attempt to understand the advantages and limitations of Smart Contracts.
RELEVANCE AND LIMITATIONS OF SMART CONTRACTS
Smart Contracts have numerous advantages. Broadly speaking these include – low costs, speedy transactions, eliminations of middlemen, greater control, etc. Recalling the functioning of Smart Contracts explained in Section I of this paper, the recording of the transactions on a ledger that is publically available renders these Contracts as more transparent and difficult to breach. Since each part of every single transaction is always available to the public, therefore it is almost impossible to modify the Code encrypted therein without anyone noticing. Owing to this transparency, it is easier to hold people accountable for their actions/inactions when they enter into Smart Contracts as opposed to Traditional Contracts. Additionally, since these Contracts are self-executing therefore they significantly reduce the transactions costs involved because the parties do not have to opt for litigation or any other dispute resolution mechanism to enforce the Contracts. The parties also save a lot of money because they do not incur any expenditure associated with expensive drafting of Traditional Form of Contracts.
Just like Smart Contracts have many advantages they also have several disadvantages. Smart Contracts may reduce the transaction costs and the drafting costs, but taking recourse to a high-level technology such as the Blockchain technology involves costs of its own. A Computer code can be extremely complex in nature and not every individual is equipped with the knowledge and skills to understand and operate the same. This might result in parties incurring a different expenditure altogether in hiring a skilled person to work on such a Code. It is of paramount importance that the code encrypted on to a computer is a correct one as an incorrect one can have serious repercussions. Another problem which may arise is the liability of the expert in case the code does not work properly and the smart contract execution is affected. Further, with the rise of Artificial Intelligence the skills and necessity of human labor is put to test, and unemployment becomes a growing concern.
Additionally, contracting via a digital mechanism significantly reduces the parties' chances of broadly defining the scope and ambit of the terms and conditions of a Contract. This disadvantage is directly linked to the problem of the limited vocabulary of a computer code as opposed to the vast and extensive vocabulary of human languages.
The next disadvantage of Smart Contracts has a very real nexus with the limitations of Artificial Intelligence. In a Smart Contract it is left to the Computer (which uses the Code) to assess whether the relevant terms and conditions are being enforced. This raises the question of Artificial Responsibility that can be explained as "the ability of machines to control important matters with limited opportunities for humans to veto decisions or revoke control." What if the Computer wrongfully assesses a given situation and the execution has very serious ramifications on either the parties or the environment? In many states, Smart Contracts are not even considered to be legal Contracts, which poses another problem as to who shall be the Defendant in a given case and whether will it be possible to even have one? Given the advancement of technology it is very much possible to exploit Artificial Intelligence and lead to world to a situation where it is at a precipice of maybe a nuclear war! Not to forget that Smart Contracts are irreversible and hence once the damage is done, it cannot be undone.
Considering the advantages of Smart Contracts, the fields of applications in which Smart Contracts remain relevant are many. These include Contracts pertaining to the 'financial and insurance sectors...areas such as Sharing Economy, Energy, Supply Chain or Identity Control.' But before broadening the scope of expansion of Smart Contracts we must bear in mind the various limitations and risks attached to Artificial Intelligence. It is very important that the use of Smart Contracts only be made in those fields in which it is easier to calculate the risks involved; the language of the Code is not extremely complex or so to say that the limited vocabulary of the language of a Computer Code is able to translate it from Traditional forms of language.
THE LEGAL QUESTIONS SURROUNDING SMART CONTRACTS
The use of Artificial Intelligence raises myriad legal questions, many of which have remained unanswered for a long period of time. In the context of Smart Contracts, these include – (i) Who shall be the defendant in a given case ; (ii) When does the Contract become legally binding ; (iii) Is the Contract a valid Legal contract in the eyes of the law?
While taking recourse to Smart Contracts, there is always the risk of entering an incorrect Code on the Computer. Given the irreversible nature of the Contract and since it is extremely difficult to modify such a Contract, the question of who shall be the defendant in a given case. Alternatively put, how shall it be determined as to who is the concerned person for committing a wrongful act? There can also be instances in which the Code was a complex one, and it was wrongfully analyzed and executed. The other question is when does the contract become legally binding. This is important to be ascertained in order to find an answer to the first question. Some suggest that it could either be when the initial terms of contract were fulfilled or when they were agreed upon.
The authors in section II of this paper have stated that a key element of traditional forms of contract is 'consideration.' Some jurisdictions like India do not consider a contract to be a valid legal contract until and unless there is valid and valuable consideration in the eyes of the parties and also the law. It is very easy to circumvent this requirement of law when enforcing a Smart contract. Furthermore, there is also a provision of law that stipulates that contract should not have an unlawful object. Since there is no administering authority to examine whether the requisite conditions of law are being fulfilled or not, Smart Contracts cannot be considered to be valid Contracts.
The introduction of Propy (a smart contract-based cross-continental marketplace for buying and selling properties) and AXA's Fizzy (a smart contract-based travel insurance scheme for flight delays and cancellations) signifies the potential and relevance of Smart Contracts. However, sudden closure of AXA Fizzy shows that proper mechanism is required before the usage of Smart Contracts is normalized.
It is evident that Smart Contracts do have a number of advantages but they also have an equal or maybe more disadvantages. Until and unless the glaring loopholes in law are filled that can keep up with the questions raised by the use of Artificial Intelligence, it is extremely important that Smart Contracts be made use of cautiously. If adequate precautions are not taken and the focus is not directed towards the development of technology and also the law, there will come a time when we are unable to contain Artificial Responsibility.
Charlotte R. Young, A Lawyer's Divorce: Will Decentralized Ledgers and Smart Contracts Succeed in Cutting Out the Middleman, 96 WASH. U. L. REV. 649, 680 (2018).
2 Jonathan G. Rohr, Smart Contracts and Traditional Contract Law, or: The Law of the Vending Machine, 67 CLEV. ST. L. REV. 71, 92 (2019).
3 Rohr, supra note 2, at 75.
4 Jeremy M. Sklaroff, Smart Contracts and the Cost of Inflexibility, 166 U. PA. L. REV. 263, [iv] (2017)
5 Sklaraoff, supra note 4.
6 Rohr, supra note 2
7 Young, supra note 1
8 Maren K. Woebbeking, The Impact of Smart Contracts on Traditional Concepts of Contract Law, 10 J. INTELL. PROP. INFO. TECH. & ELEC. COM. L. 105, [i] (2019).
9 Chidambara v. P.S. Renga, AIR 1965 SC 193 (India).
10 Indian Contract Act of 1872, § 31.
11 Sklaroff, supra note 4.
12 Young, supra note 1, at 658.
13 Woebbeking, supra note 8, at 106.
14 Young, supra note 1, at 658
15 Adam J. Kolber, Not-So-Smart Blockchain Contracts and Artificial Responsibility, 21 STAN. TECH. L. REV. 198, 205 (2018).
16 Woebbeking, supra note 8, at 107.
17 Young, supra note 1, at 657
18 Young, supra note 1, at 661.
19 Young, supra note 18.
20 Young, supra note 18.
21 Indian Contract Act of 1872, § 2(d).
22 India Contract Act of 1872, § 24.
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