Smart Contracts – what are they? Are they enforceable?

Smart Contracts – what are they? Are they enforceable?

Along with the Bitcoin craze in the past few years emerged a new idea: now that we have access to digital money, we may be able to do something paper cash never could; program the money. Overshadowed by the controversies surrounding cryptocurrency investing, blockchain technology shows a lot of promise for a variety of useful applications, such as secure decentralized private records (e.g., medical or transaction records), autonomous marketplaces, or smart contracts.

In this article, I will outline the potential uses of smart contracts and their legal status in the UK.

What is a smart contract?

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“Smart contract” is a term used to describe an agreement written as a computer code stored on a blockchain-based platform. Smart contracts can be either fully written in code, or only certain provisions, such as transferring funds from one party to another, can be executed through the code. In simpler terms, they are computer programs stored in a blockchain database that run when predetermined conditions are met. The aims and advantages of smart contracts are to provide higher security during transactions and reduce costs associated with traditional contract execution. For more about Blockchain and how it works, make sure to read this article, in which we looked at blockchain a little closer.

What makes smart contracts unique is the fact that they have the ability to perform certain tasks themselves. A traditional contract, whether in paper or digital form, has no actual power to act on its own as it simply guides the parties involved in a contractual relationship. Smart contracts, on the other hand, have a certain degree of autonomy, meaning they can perform certain tasks without human assistance. In most cases, such tasks are still limited and mainly involve the automatic transfer of cryptocurrency from one account to another upon the satisfaction of a specific contract condition; for example, releasing completion monies as soon as both parties sign a residential conveyancing contract. This diminishes the need for a manual transfer of money which is often associated with delays or late payments.

However, as technology becomes increasingly complex, it can be expected that in a few years smart contracts will be able to understand more sophisticated concepts of contract law, such as commercial reasonableness. Nowadays, smart contracts often operate as vehicles to execute certain provisions of a traditional text-based contract, rather than being fully code-based; it is safe to say that such hybrid provisions are, at the moment, safer than code-only contracts at least until there is complete clarity on their enforceability and until parties are fully comfortable with smart contracts.

How does a smart contract look like?

Someone without coding experience will barely understand what the above smart contract snippet is about. As the words will and isDeceased suggest, this is an incomplete example of a will written as a smart contract in Solidity. Solidity is a programming language specifically designed for writing smart contracts and is based on the Ethereum blockchain platform, the second-largest blockchain platform after Bitcoin (as well as the second-largest cryptocurrency). Solidity was designed to make writing code easier for those who are familiar with any other programming language, and the limited nature of its use also adds to its simplicity. However, to someone with no or little coding experience, the programming concepts that Solidity requires may be impossible to grasp. Nonetheless, it is still beneficial to understand what smart contracts are and what they look like.

A smart will like the one above can be deployed to hold assets on behalf of the testator and programmed to release the assets according to the testator’s wishes, effectively eliminating the need for any sort of a middleman, lawyer, or arbitrator. However, as wills are subject to necessary formalities while often also dealing with inevitable ambiguities which computers do not yet understand, smart wills are far from being fully practical in present circumstances. Nonetheless, the idea is a good example of what could be achieved with smart contracts.

As for now, before a smart contract can be executed on the blockchain network, an additional step is required, namely, the payment of a transaction fee for the contract to be added to the chain and executed. In the case of the Ethereum network, smart contracts are executed on the Ethereum Virtual Machine (EVM), and this payment, made through the Ethereum (ETH) cryptocurrency, is known as “gas.” The amount of gas that must be paid to execute the smart contract depends on the complexity of the code; this is mainly to prevent extremely long and complex contracts from overwhelming the virtual machine. The costs of mathematical operations that a smart contract may require are precisely defined in Ethereum’s Yellow Paper (example below).

A simple subtraction operation, e.g., ‘residuary estate = total distributed (tax + debt + fees)’, would cost 15 gas (gwei units), or about 0.000021 GBP (0.0000288 USD). Additional costs, such as the standard transaction fee of 21,000 gwei and contract creation fee of 32,000 gwei (totalling to 0.1018 USD or 0.074 GBP), would be added. This demonstrates that the costs associated with the deployment of a smart contract are extremely low.

1 USD equals to 0.00054 ETH which equals to 541,590 gas unit (gwei) as of March 31, 2021.

Enforceability of smart contracts

On November 11, 2019, the UK Jurisdiction Taskforce (UKJT) published a statement with key findings on the legal status of smart contracts and cryptocurrencies. One of the key findings was that smart contracts are fully capable of satisfying the requirements of English law contract formation principles and can, therefore, be interpreted and enforced using well-established legal principles.

There is a contract in English law when two or more parties have reached an agreement, intend to create a legal relationship by doing so, and have each given something of benefit. A smart contract is capable of satisfying those requirements just as well as a more traditional or natural language contract, and a smart contract is therefore capable of having contractual force. Whether the requirements are in fact met in any given case will depend on the parties’ words and conduct, just as it does with any other contract.

The parties’ contractual obligations may be defined by computer code (in which case there may be little room for “interpretation” in the traditional sense) or the code may merely implement an agreement whose meaning is to be found elsewhere (in which case the code is unimportant from the perspective of defining the agreement). Either way, however, in principle a smart contract can be identified, interpreted, and enforced using ordinary and well-established legal principles.

Source: UK Jurisdiction Taskforce, Legal statement on cryptoassets and smart contracts [18].

However, where most issues may arise is the alignment of the actual agreement between the parties and the coded provisions. It is common for contractual disputes to arise from poor or ambiguous wordings (the literal contractual layer), which may sometimes differ from the commercial context/reality layer that UK courts often consider during contractual interpretation. With smart contracts, an extra layer — the actual code — must be considered along with the standard interpretation of the language used. Therefore, smart contracts might sometimes generate more legal issues than they aim to solve, and parties may have to consider risk allocation in the event of an error in the code occurring. On the other hand, the UKJT also stated that code is generally (but not always) a clear and unambiguous language and that it would require “very unusual circumstances for a judge to conclude that the objective meaning was other than what the words (code) said.” (UKJT statement, [150]).

To summarise briefly, smart contracts, despite inevitably dealing with novel legal and technical difficulties, are already employed for a variety of practical applications. Just like legal technology in general, they may be overestimated in the short run, with close to no present use in complex contractual circumstances but offer revolutionary ways to the way parties will contract in the future.

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