The implementation of smart contracts in business is expected to speed up transactions and enable digitization of a wide variety of physical assets, such as oil and gold. But the legal and regulatory underpinnings of smart contracts are still shaky and rife with their own set of problems. Resolving disputes between parties is the biggest one.
What Are Smart Contracts?
Before delving into a discussion about dispute resolution in smart contracts, it is necessary to first understand them. Smart contracts are similar in structure and philosophy to their offline counterparts in that they promise a set of services in exchange for money. But they are implemented digitally. Thus, a physical or digital action is triggered when a certain set of criteria defined in code is met. For example, property rental agreements can be encoded with conditions that enable a landlord to release their smart lock, once a rental payment is made. (See also: Are Smart Contracts The Best Of Blockchain?)
Depending on the terms of a business transaction and the extent to which they are encoded, smart contracts can be of four different types: completely encoded contracts in which the code is considered as law, contracts in which terms outlined in code are duplicated with natural language terms, contracts in which certain terms are outlined in code and the rest in natural language, and contracts whose terms are set in natural language but have a digital component. (See also: Ethereum Smart Contracts Vulnerable To Hacks).
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The Dispute Problem With Smart Contracts
In theory, smart contracts sound efficient. But there are several problems related to their implementation.
For starters, smart contracts assume ideal actors, economic incentives, and perfect legal settings. That may not always be the case. In the example above, the home may not turn out to be as advertised and the tenant may want their money back. A legal problem would arise if the landlord refuses. A similar situation occurs when the tenant trashes the place before leaving. Because smart contracts can be executed without a physical meeting, the potential for a fraud or misrepresentation is high. Then there are other problems pertaining to smart contracts, which are echoes of the general anxiety related to the creeping advance of algorithms in regulating our existence. For example, who is responsible for coding errors or if the system malfunctions due to certain conditions?
Enforceability And Jurisdiction
But the two biggest legal problems of smart contracts lie in their blockchain provenance. The first one is the enforceability of smart contracts. Blockchain came into mainstream prominence as a decentralized and permission-less system that can be used to speedily conduct business transactions between multiple geographies. Current dispute resolution of contracts differs between countries and is settled in courts.
But blockchain works in the opposite manner. Consensus for a transaction is a function of agreement between multiple nodes in a network that, in a complex system, may reside in multiple geographies. How will a decentralized system arrive at a consensus regarding disputes among stakeholders? Permissioned blockchains have a line of authority that helps resolve disputes. But they typically operate within private enterprises. For permission-less blockchains, which operate within the public realm, the problem is still there.
There is also the problem of jurisdiction. How will disputes involving smart contracts for international transactions that span multiple geographies be resolved? More specifically, will the different jurisdictions involved have to work in concert with each other to piece together a judgment or resolution to disputes? The problem becomes further complicated when you consider the legal status of blockchain. Some states have taken the lead in recognizing smart contracts while others are still arriving at an understanding of the technology and its application to their society. The varying interpretations of contract laws with respect to blockchain could also present their own set of problems.
What Is The Solution?
The complexity of the problem notwithstanding, blockchain startups are already tackling the problem. In addition to this, reputable law firms have some common themes from their planned products. Crowdsourcing of jury members from across the world is one. Once an arbitration clause is inserted into a smart contract, judgments to resolve disputes can be crowdsourced by appointing arbiters, who quote a price for the task, from across the world. Using the framework for Electronic Data Interchange (EDI), already used by banks for messaging between different jurisdictions, is another. This approach may be effective for smart contracts that distribute responsibility between humans and code. EDI was developed in the 1960s with the same goal as smart contracts: to enable seamless transactions between borders. As such, their scope of operations – international technology-based exchange of funds – has an overlap with that for smart contracts.
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