Smart contracts are a revolutionary step in the digital and legal worlds. While not every smart contract is a legal contract, a smart contract is often a streamlined, digital expression of consent that happens to be stored on a blockchain. The growing popularity of smart contracts raises the question of not whether disputes will arise from their use but how breaches of smart contracts will be resolved. Users of smart contracts have already identified arbitration as a mechanism well suited to the novel needs of blockchain disputes. This article explores the role of alternative dispute resolution (ADR) in smart contract disputes, with a focus on the United States.
Despite their appellation, smart contracts are neither smart nor always—or even often—legally binding contracts. A smart contract is a computer program or transaction protocol that automatically executes certain actions once certain terms are met. A useful analogy is to that of the vending machine: once the dual terms of a certain amount of currency and the push of a button are met, the program (i.e., the smart contract) automatically executes by dispensing an item.
Smart contracts consist of a series of conditional "if-then" statements in lines of code, which automatically enforce the contract's terms. They have the potential to replace traditional contracts in many different contexts. In the insurance industry, for instance, certain policy agreements could be automated through the use of a smart contract. To give a simple example, the code for a smart contract could be written to provide for automatic payment in case of a flight cancellation. Once a cancellation is posted, the smart contract would self-execute by making a payment directly to the policyholder, bypassing the cumbersome traditional claims process entirely. This is precisely how smart contracts are designed to operate: independently from human intervention.2 The simplicity and binary nature of smart contracts distinguish them from traditional legal contracts. There is no artificial intelligence involved in smart contracts; they are essentially self-executing agreements, with their terms directly written into lines of code.3
Smart Contracts: A Troika of Decentralization, Immutability, and Anonymity
Proponents of smart contracts tout that they increase efficiency and cut administrative costs by reducing the need for human intervention. In the travel insurance example above, once the flight is canceled, the corresponding funds will transfer from one party to another—without the need for further action by any party. For that reason, smart contracts have become increasingly common in both the cryptocurrency and non-fungible token markets, which are both similarly skeptical of human intervention.
Smart contracts are often used to "constrain[] how" these digital assets "can be sold or transferred."4
Smart contracts, stored on a blockchain, differ from traditional contracts in three fundamental aspects, discussed in turn below:
- Decentralization,
- Immutability, and
- Anonymity (in principle).
Transactional data has historically been stored in one place, such as a government or bank server. By contrast, blockchain technology spreads that data across many servers and computer hardware owned by ordinary users. All transactional information is permanently recorded and accessible to all parties, regardless of where they are located geographically or their status as a consumer or not.5 This decentralization of information is meant to reinforce the data's credibility.6 As with physical chains, if one link is weak, the entire chain can break. Blockchain technology is designed to make every link so strong that the chain cannot break. The main function of this technology is to transfer money between parties directly, removing the need for an intermediary such as a bank or government to be involved in the transaction.7
Because blockchain technology decentralizes data across many computers, altering the data becomes impossible. This ensures that blockchain is immutable. Once a block (i.e., a transaction) is added to the chain, it cannot be erased or taken off the chain.8
Another key component of blockchain technology is the presumption that its users are anonymous.9 Transactions take place between two cryptographic keys rather than two individuals.10 While this feature of blockchain is designed to guarantee privacy and non-discrimination, it can also be a means for users to hide their identity—to criminal ends, for example.11 It is worth noting that the long-held myth of anonymity in blockchain transactions has been busted by the pioneering work of Sarah Meiklejohn and other researchers.12 As explored further below, the presumption of anonymity nonetheless poses issues in the context of dispute resolution.
Off-Chain and On-Chain Disputes
Conflicts arising from smart contracts are typically categorized into "off-chain" disputes and "on-chain" disputes.
Off-chain disputes occur outside the blockchain ledger and involve issues that are not directly recorded or resolved on the blockchain. These disputes can arise from a variety of issues, such as disagreements over the terms of a contract that is related to a blockchain transaction but not encoded in a smart contract, or issues with off-chain services that interact with the blockchain, such as exchanges or wallet providers. Off-chain disputes are typically resolved through traditional legal systems or ADR methods, such as arbitration or mediation. The resolution process for off-chain disputes is not governed by the blockchain protocol and involves human intervention.13 In sum, off-chain disputes only differ from other non-blockchain disputes in their subject matter.
On-chain disputes, by contrast, refer to controversies arising out of transactions or interactions that occur directly on a blockchain. These disputes are inherently tied to the immutable and transparent nature of blockchain technology. Since all transactions on a blockchain are recorded on a public ledger and cannot be altered once confirmed, on-chain disputes typically revolve around the execution of smart contracts, the transfer of digital assets, or the interpretation of encoded rules within the blockchain protocol. The resolution of on-chain disputes often relies on the underlying code and consensus mechanisms of the blockchain itself. For example, as discussed below, a smart contract may include built-in dispute resolution mechanisms that automatically enforce the terms agreed upon by the parties involved.
The dispute resolution mechanisms for off-chain and on-chain disputes differ significantly. Off-chain dispute resolution allows for more flexibility and human discretion, as it can take into account a wider range of factors and nuances that may not be captured by code.14 On-chain dispute resolution, by contrast, is automated and enforced by the code running on the blockchain, which is executed by the network's nodes. This code-driven approach aims to minimize the need for trust between parties and reduce the potential for human error or bias. However, it ignores the potential human bias at the coding stage, and it can be inflexible, as it strictly adheres to the predefined rules of the smart contract or protocol.
ADR Is Poised to Become the Future of Dispute Resolution for On-Chain Disputes
On-chain arbitration covers a range of procedures and constructs, from using blockchain technology to enhance traditional off-chain procedures to more radical departures from traditional forms of ADR.15 On one end of the spectrum, on-chain disputes can rely primarily on traditional dispute resolution mechanisms (an on-chain dispute is submitted to a court or arbitrator). On the other end, wholly blockchain-based ADR mechanisms can exist (an on-chain dispute is submitted to a protocol such as Kleros, described below). The case study described below falls somewhere in between, providing for a human arbitrator but mandating use of the Kleros protocol.
Many of arbitration's existing advantages over litigation also make arbitration an ideal means of dispute resolution for blockchain disputes. For example, in the novel and dynamic world of blockchain and cryptocurrency, the parties' ability to appoint subject matter specialists as arbitrators in an arbitration can better meet the parties' needs than a generalist judge in a litigation who may be unfamiliar with burgeoning new technologies. Additionally, in contrast to U.S. litigation, parties in arbitration can easily agree to provide for privacy and confidentiality—two of blockchain technology's defining characteristics.16 Arbitration can also provide a one-stop multijurisdictional resolution to a dispute—critical for smart contracts, which frequently involve cross-border dealings. Still, traditional dispute resolution mechanisms may require some retooling to specifically suit on-chain disputes.
On-Chain Dispute Resolution Services Face Nascent Challenges
Because smart contracts are written predominately or entirely in code, arbitration agreements must be carefully placed to ensure proper notice for parties. U.S. courts, for example, will enforce arbitration agreements only if notice of the same was "reasonably conspicuous."17 In the absence of actual notice, for digital contracts, the U.S. Court of Appeals for the Second Circuit "look[s] to the design and content of the relevant interface to determine if the contract terms were presented to the offeree in [a] way that would put her on inquiry notice of such terms."18 In making a similar determination under Florida law, the U.S. District Court for the Southern District of Florida considered how a particular cryptocurrency token was acquired. Since one of the plaintiffs had purchased the token by sending Ether, a cryptocurrency, directly through a smart contract, the court concluded that the arbitration clause contained in a separate Token Sale Agreement was unenforceable.19 To avoid a similar outcome, clickwrap agreements can help ensure the enforceability of an arbitration agreement in on-chain disputes, although the inquiry remains fact-intensive.20
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Footnotes
1.The authors are associates in the New York office of Mayer Brown LLP. Mayer Brown summer associates Sébastien Deligne, Vasili Sgourakis, and Jane Tullis assisted in the preparation of this article.
2. See Chandrika Sharma, Blockchain Arbitral Award: Potential Challenges in Recognition and Enforcement Under the New York Convention, 16 Revista Română de Arbitraj 85, 92 (2022) (internal citations omitted).
3. See Rensel v. Centra Tech Inc., 2018 WL 4410110 at *10 (S.D. Fla. June 14, 2018) (citing Tsui S. Ng, Blockchain and Beyond: Smart Contracts, Am. Bar. Assoc.: Bus. L. Today (Sept. 28, 2017)).
4. Hermès Int'l v. Rothschild, 654 F. Supp. 3d 268, 274 (S.D.N.Y. 2023).
5. How does blockchain work?, Stanford Online, https://online.stanford .edu/how-does-blockchain-work).
6. Orna Rabinovich-Einy & Ethan Katsch, Blockchain and the Inevitability of Disputes: The Role for Online Dispute Resolution, 2019 J. Disp. Resol. (2019) (quoting Leslie Lamport, The Part-Time Parliament, 16 ACM Transactions on Comput. Sys. 133, 155-57 (1998)).
7. Pietro Ortolani, The Impact of Blockchain Technologies and Smart Contracts on Dispute Resolution: Arbitration and Court Litigation at the Crossroads, 24 Uniform Law Review, 430, 431 (2019).
8. Stanford Online, supra note 5.
9. Reggie O'Shields, Smart Contracts: Legal Agreements for the Blockchain, 21 N.C Banking Inst. J. 177, 191 (2017).
10. Maxime Chevalier, From Smart Contract Litigation to Blockchain Arbitration, 12 J. of Int'l Disp. Settlement 558 (2021) (citing Nataliia Filatova, Smart Contracts from the Contract Law Perspective: Outlining New Regulative Strategies, 28 Intl'l J. L. and Tech. 217 (2020)).
11. See Rabinovich-Einy & Katsch, supra note 6, at 8.
12. See generally Andy Greenberg, Tracers in the Dark: The Global Hunt for the Crime Lords of Cryptocurrency (Doubleday 2022).
13. See Dirk Wiegandt, Blockchain, Smart Contracts and the Role of Arbitration, 39 J. Int'l Arb. 671, 687-89 (2022).
14. Id. at 688.
15. See id. at 680-87.
16. Id. at 685-86.
17. In the absence of actual notice, for digital contracts, the U.S. Court of Appeals for the Second Circuit "look[s] to the design and content of the relevant interface to determine if the contract terms were presented to the offeree in [a] way that would put her on inquiry notice of such terms."
18. In making a similar determination under Florida law, the U.S. District Court for the Southern District of Florida considered how a particular cryptocurrency token was acquired. Since one of the plaintiffs had purchased the token by sending Ether, a cryptocurrency, directly through a smart contract, the court concluded that the arbitration clause contained in a separate Token Sale Agreement was unenforceable.
19. To avoid a similar outcome, clickwrap agreements can help ensure the enforceability of an arbitration agreement in on-chain disputes, although the inquiry remains fact-intensive.
20. See, e.g., Sgouros v. TransUnion Corp., 817 F.3d 1029, 1033-34 (7th Cir. 2016) ("Courts around the country have recognized that [an] electronic 'click' can suffice to signify the acceptance of a contract," and that "[t]here is nothing automatically offensive about such agreements, as long as the layout and language of the site give the user reasonable notice that a click will manifest assent to an agreement."); Meyer, 868 F.3d at 75 (citing Fteja v. Facebook Inc., 841 F. Supp. 2d 829, 837 (S.D.N.Y. 2012) (collecting cases)).
Originally published by Dispute Resolution Journal
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