• Farshad Ghodoosi

Digital Solidarity: Contracting in the Age of Smart Contracts


In a recent paper, I offer a new theory of smart contracts covering formation to enforcement. In particular, the paper makes two contributions: 1. contract-as-tort theory best describes smart contracts 2. Users' voting (proof-of-work) leads to the most effective on-blockchain dispute resolution.

Increasingly, we give up our decision-making processes to machines and algorithms. Examples include our investment or retirement accounts (if we are lucky enough to have them) in which algorithms and robo-advisors automatically balance our investment portfolios. These algorithms—which are often run and maintained by investment companies—determine our contractual obligations.

There are emerging digital platforms, however, that include algorithms and computer codes that are immutable, self-enforcing, and often non-modifiable. Innovators create these platforms while not holding much discretion in changing the underlying codes. Moreover, these platforms allow users to upload their algorithms that can trigger transactions under certain conditions. These algorithms are smart contracts. The definition of smart contracts remains controversial; in this paper, I define smart contracts as computer codes that automate all or parts of contracting while allowing machines to form, validate, and enforce contracts. Smart contracts are similar to vending machines with one important caveat. In smart contracting, two vending machines transact simultaneously without human involvement. In this paper, in particular, I look at contracts that are formed, validated, and enforced by machines in a distributed network.

So, what is exactly the problem? It is estimated that there are already 30 million smart contracts out there and the number is only increasing with nearly 1 million smart contracts being created every month on just one of the platforms (Ethereum). In 2018, a study suggested that over 34,000 smart contracts have some level of code flaws leading to other studies examining smart contract vulnerabilities. We saw an example of exploiting the terms of smart contracts in 2016 where a user—which others called hacker—used the term of a smart contract to transfer approximately $60 million to another account. In a letter, the attacker stated that it simply used the “explicitly coded feature as per the smart contract terms” and admonished those who called this transfer a “theft.” Understanding the legal consequences for incidents such as the 2016 attack requires an analysis of the nature of smart contracts from contract law theory. My paper therefore focuses on the contractual nature of smart contracts

What is the legal framework for algorithms and robots transacting on our behalf especially when the connection between assent and the transaction is very thin with no human involvement? One view is that smart contracts are just another tool that function similar to an escrow agent that helps facilitate transactions. Another view dismisses smart contracts as neither smart nor contracts. Some of these approaches may have been correct a few years ago but with the advancement in technology along with the combination of blockchain, artificial intelligence, and the internet of things, smart contracts have developed and will continue to develop. Moreover, these platforms which allow smart contracts often include a term stating that the code is law between parties emphasizing that nothing, but the underlying code of smart contracts constitutes the private law between the parties.

In this paper, I offer a new theory of smart contracts and a new form of resolving contractual disputes based on distributed ledger technology. The paper suggests that smart contracts should be analyzed through the lens of reliance-based (contract-as-tort theory) contracting, which is an older theory of contract law in the United States. This theory suggests that contracts are enforceable because people rely on promises even if there is no meeting of the minds (mutual agreement). In smart contracting, there is no agreement in the traditional sense since codes simply transfer or receive digital assets once a condition is fulfilled (e.g. a smart contract automatically transfers digital currency to the highest bidder in a digital auction). The basic for enforceability of smart contracts, I argue, is not an agreement between (electronic agents) but the reliance on codes.

Next, the paper reexamines the efforts to build blockchain-based dispute resolution mechanisms, analyzes the seismic shifts in contractual disputes, and offers new insights into its features including decentralized decision-making, network-based dispute resolution, and outside-of-judiciary enforcement of decisions. The paper argues that by including an ex ante dispute resolution mechanism in smart contracts codes, more complex contracts can be smart. If a dispute arises, other users, who are also invested in the reliability of the network, can anonymously vote to resolve the dispute. With this approach, the human connection will be brought back to contracts but this time only at the dispute phase. This marks a shift from traditional contractual solidarity—which is based on pre and post human interaction—to what I call digital solidarity.

Farshad Ghodoosi - Morgan State University


Copyright © 2018 All Rights Reserved. Faculty of Law, The Chinese University of Hong Kong

The Chinese University of Hong Kong