Smart Contracts: A Requiem
Dr Eliza Mik - Centre for AI & Data Governance, Singapore Management University and Tilburg Institute for Law, Technology and Society, Tilburg University.
-- “Smart contracts” exemplify the trend to rely on technology to substitute subjective, unpredictable human decision-making with objective, predictable algorithms. Existing analyses of “smart contracts” are, unfortunately, difficult to follow due to an undisciplined use of domain-specific terminology. While lawyers construct arguments based on ill-understood technical concepts, coders indulge in an uninformed use of legal nomenclature. This paper demonstrates that debates regarding the enforceability of “smart contracts” are inherently misplaced.
The term “smart contract” has no fixed meaning. It is often used interchangeably with “cryptocurrencies,” “tokens,” or methods of creating or transferring tokens. Consequently, each “smart contract” should be analysed individually, depending on the definition taken as a point of departure and on its practical implementation. The particular attributes of a “smart contract” depend on how it interacts with its native blockchain, if any. As most “smart contracts” operate “on top of” their blockchains and do not leverage all of their characteristics, they should be evaluated like any other software application.
The difference between “regular” applications and “smart contracts” lies in the fact that the blockchain provides a distributed (and often decentralized) execution environment, where each “smart contract” is executed by many independent nodes. The benefit of such “distributed execution” lies in its efficiency, security and impartiality. Traditional execution environments, such as operating systems, are generally centralized and inherently prone to security breaches. Consequently, the difference between “traditional” software applications and “smart contracts” does not lie in the quality of their code but in the manner such code is executed. In practice, “smart contracts” are susceptible to programming errors and create many security challenges. As “smart contracts” are supposed to be immutable, they cannot be amended or stopped. Their ability to guarantee performance is, after all, premised on the impossibility of interfering with their execution and modifying their code. This means, however, that the code of “smart contracts” cannot be changed - even when circumstances change or when coding errors are discovered.
Technicalities aside, it is recognized that for “smart contracts” to gain mainstream acceptance, they must fit within existing law and/or be legally enforceable. Doubts concerning their enforceability usually concern the questions whether agreements can be expressed in code and whether their formation and performance can be automated. First, there are no doctrinal obstacles to expressing contracts in code. Statutory exceptions aside, contract law does not prescribe how agreements are to be made or how the parties should express their intentions.
Doubts concerning the enforceability of “smart contracts” (which are written in code) stem from a failure to distinguish between the substance of the contract, i.e. the rights and obligations agreed by the parties, and its expression, i.e. the document containing the words describing such. Courts do not enforce contracts but individual obligations, be it by ordering the contract breaker to pay a sum of money in damages for non-performance or, exceptionally, by ordering its actual performance. Similarly, courts do not enforce clause or terms but the obligation described therein. As obligations are expressed in words, inquiring whether code is enforceable is tantamount to asking whether words are enforceable. The physical representation of the agreement, be it words printed on paper or displayed on a screen, is not the agreement. The medium used to memorialize the agreement constitutes proof of the parties’ obligations but it does not create them. Of course, the manner of expression affects the difficulty of establishing what has been agreed. This, however, is a question of evidence, not substance.
Second, the possibility of automating both the formation of contracts and their performance is acknowledged by common law and recognized by e-commerce regulations, such as the Convention on the Use of Electronic Communications in International Contracts. Notwithstanding the foregoing, it is generally overlooked that enforceability requires the presence of consideration; i.e. something given in return for the other party’s promise. The concept of “consideration” emphasizes the mutual nature of contracts as bargains. It is trite law that consideration need not be adequate but only sufficient in the eyes of the law. The parties can exchange money for goods or bitcoins for crypto-assets. While contract law does not require equivalence of value, it requires reciprocity. Consequently, if a “smart contract” does not involve an exchange, questions of its enforceability do not arise. In practice, “smart contracts” constitute unilateral transfer mechanisms or technological means of automating the performance of an obligation deriving from an underlying agreement or simply a mechanism facilitating the generation, transfer and exchange of crypto-assets. It is possible to analyse them in terms of legal effects, but not in terms of enforceability.