Law and Technology

Are smart contracts feasible? (2/3)

Binit Agrawal

Not without state support.


This post is the second entry in our ‘Smart Contract’ series.

The Issue of Jurisdiction

On the online forum of Ethereum (the front-runner in Blockchain technology), a query was raised. The user wanted to know how the legality of a certain smart contract would be determined. The answer was not easy, as the contract was entered into by a Chinese investor, with a Swiss firm, and was verified in Australia and USA, and the laws of all these countries came into conflict on several points.

The standard response to issues like these is to raise a clarion call for the creation of a more global society. While efforts to create a unified society have started to materialise in the European Union, the same is not true for the rest of the global marketplace. Public Blockchain technology, famed for its decentralized nature, has its nodes spread all over the world. This creates potentially hundreds of jurisdictions under which a dispute might fall.

A contract which is not valid in one jurisdiction might be valid in another and parties will aim to take benefit of this. Consequently, the trustless system being talked about will fail. Even though there will be immediate execution, the probability of post-execution litigations will be high. This will mean that issues of trust will be prevalent. Hence, parties will be forced to undertake discussions and must pre-decide jurisdiction. Therefore, self-executing, intervention-less contracts will not see the light of the day. The only way this dilemma can be resolved is through additional regulatory measures. Regulatory mechanisms in the nature of laws mandating jurisdiction on the basis of an outlined criteria will be needed. Further, in order to avoid conflict of nations, state diplomacy and international regulatory efforts will also be a must. This means the role of the state, government and regulatory bodies will become ever more important, as against a withdrawal of the government’s role. This is comparable to the predictions made in the early days of the internet. It was widely believed by enthusiasts that internet will lead to a death of regulation and government. In the present day, nothing could be farther from the truth.

Human Uncertainty v. Rigidness of Self Execution

The most touted benefit of smart contracts is that they are self-executing and that execution is either completed or starts as soon as acceptance is made. However, this is a double-edged sword. Even while ensuring efficiency, this rapid execution creates practical problems which will make smart contracts unfeasible for multiple contractual deals. Contracts, after all, are exchanges between humans and are supposed to take place in the real world. As the fact stands, both humans and this world are open to the pitfalls of uncertainty. A contract might become impossible in the real world even though information on it has already been shared.

A good instance to highlight this issue is the sale of artwork. In a case where the seller genuinely believes the piece to be genuine, but after the sale has been concluded, it turns out that the piece is, in fact, a fake and there was misrepresentation of information, the contract will be rendered invalid post-execution. As such it will be impossible for parties to account for all such information in self-executing and self-contained yes-no contracts. Consequently, post-contract transaction and litigation costs will negate any potential benefits. These issues can only be resolved when the law protects the weaker parties like buyers, and creates effective online return mechanisms and systems for verification of proper execution by the contractual parties.

Contingent Contracts and Source of Information

The next practical issue arises when the execution of a smart contract is contingent. An example can be that of farm insurance, which requires payments to be made depending on weather conditions. As such, smart contracts will require a source of information which feeds them weather reports. This is not possible through a decentralized source of verification of such information. For instance, a  person in New York cannot verify a transaction of this nature in India. For this, the contracts will have to rely on what are called Oracles, which are standardized sources of information. As such, Blockchain platforms will have to rely on specific bodies to provide this information. Therefore, the aim of not relying on centralized bodies is not feasible.

Issues on Security and Privacy can be found in the third entry in the series.

Categories: Law and Technology