Some of the biggest challenges in scaling blockchain solutions revolve around setting up an effective governance framework, particularly a component to manage the processes by which disputes among parties are properly settled. A new paper from the World Economic Forum (WEF) and Latham & Watkins explores forward-looking practical options for different dispute resolution mechanisms distilled from case studies, various existing solutions, and blockchain-based dispute resolution protocols.
The paper outlines the following five key insights to help market participants — blockchain professionals, businesspeople, and lawyers — not only plan for disputes related to on-chain transactions, but anticipate disputes that may arise in new and unexpected ways.
- Consensus Still Needed on Dispute Resolution Protocols
While there are many blockchain networks testing protocols and resolution systems, there is no consensus on how to facilitate dispute resolution for on-chain transactions. Certain dispute resolution protocols may work well for some networks, but not for others. Networks should seek to provide widely accepted, trusted dispute resolution methods before disputes arise to avoid risking costly litigation. The existence of an available dispute resolution mechanism can actually provide parties with the incentive to create a negotiated settlement rather than incur the costs associated with the dispute process. Parties are more likely to choose a dispute resolution mechanism if the process is known to produce reliable outcomes.
- Is On-chain Enforcement Necessary?
Many blockchain-based dispute resolution protocols focus on specific enforcement of transactions—that is, ensuring that the exact assets that are subject to the dispute are transferred to the correct party—and the goal of the protocols is to enforce transactions through means that are as automated as possible. However, such specific enforcement is only necessary if parties operate anonymously and their assets (other than those subject to the dispute) cannot be identified. The vast majority of awards in business disputes are not specific performance but are monetary damages. For a network of enterprise users, who most likely all know each other, the ability to name a counterparty in a dispute proceeding and access assets to enforce the results of that proceeding will not be an issue. Of course, parties should choose a dispute resolution mechanism that a court will respect, should a party need to access off-chain assets to satisfy a judgment.
- Off-chain Governance Is Still Paramount
Dispute resolution is distinct from the governance processes that are required for most blockchain-based enterprise projects. Governance procedures involve a larger set of stakeholders than the number of participants in a single transaction, and a governing body is responsible for updating and modifying dispute resolution mechanisms. The governing body of a network must decide whether to provide dispute resolution in-network, whether to stipulate a jurisdiction for on-chain transactions, and whether users are able to opt out of either of these provisions. Each of these decisions will have an impact on the outcomes that users can expect from conducting transactions using the network.
- Different Mechanisms for Different Disputes
Participants in a blockchain network may determine that the best way to resolve disputes is by the network participants deciding for themselves, potentially guided by the network operator. Network operators would be incentivized to formulate a dispute resolution process that appears streamlined, unbiased, and low-risk. And network participants would be incentivized to adjudicate disputes fairly based on the desire for the network to continue to function and because they may be subject to judgment themselves. However, while the participants in a network may determine that some disputes are best resolved internally, other disputes may be significant beyond one network. And participants may desire the legitimacy conferred by an industry standards body. In these situations, network operators may look to semi-private industry for a resolution. Despite these other dispute resolution mechanisms, parties to an on-chain transaction dispute may still decide to pursue arbitration or litigation.
- Dispute Resolution Mechanisms Are Key to Network Adoption
Well-functioning dispute resolution is crucial for achieving the best outcomes on the blockchain network. Without dispute resolution mechanisms, some parties may experience suboptimal outcomes For example, parties may incur large litigation costs in the process of resolving their dispute. They could also choose to forego the efficiencies provided by network adoption or investment in custom agreements because there is no way to recoup their costs should transactions break down. This reduces the value to those potential participants and also to the network as a whole. A blockchain network with clear dispute resolution protocols will find it easier to onboard enterprise participants who seek certainty with respect to their operations, and a network can more easily grow when that certainty is embedded in the platform's governing and operational documents.
Originally Published by Latham & Watkins, December 2020
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