• CFRED CUHK Law

Tokens, 'Smart Contracts' and System Governance

Diana Vieira Fernandes, IN+ Center for Innovation, Technology and Policy Research, Instituto Superior Técnico (Universidade de Lisboa)


-- Cryptocurrencies embodied or represented in a “smart contract” may at first glance appear to be a new asset class, depending on the internal method of classification and the different frameworks applied. However, most of the concepts found in these devices are not necessarily new or innovative. This is because the digitalization of databases, information and systems do not change the underlying object.


My recent paper, “Tokens, 'Smart Contracts' and System Governance”, examines both the micro-level (token) and the level of exchange (as a means of exchange) in a given contract, as well as the necessary infrastructure (messages, communications, and transmission).

The paper analyzes the object of the transaction (tokens and its underlying regime), focusing on the general description and features of the smart contract in connection with contract law. As all contracts must have an object, recalling the concept of technological neutrality, the applicable law may change considerably depending on the underlying object. The concept of substance over form demands such, whereby many “tokens” can be considered void and null by lack of object. The classification of what object is being represented (tangible or intangible) does not necessarily need new specific regulation, as the various options available can be decomposed and interpreted according to existing legal theory (with respect to what is being issued or transferred).

Considering the meaning of “smart contract,” there are several classifications of what “smart” stands for, as it is self-executable, as are other contracts, namely the standardized contracts used in securities trading. A smart contract is not “smart” in the sense of “intelligence” as that word is used in other areas. All smart contracts have to be deterministic and operate within a closed system, where standardization plays a great role. Otherwise, it is not possible to be operated by a computer (where states, events, and transitions need to be defined a priori).

As tokens represent fungible assets, they should also be analyzed under the known regimes of deposit commingling and mixture (civil law) and bailment and deposit (common law) or receipts and keys. Primary question regard “control” and “possession” of assets.


My paper analyzes, in particular, the case of payment tokens (contrasting with fiat currency, in a narrow sense, as well as with hybrid cases, such as so-called “stable coins”), across jurisdictions. This analysis includes law in Switzerland, the UK, Germany, and the US (as representing the major regulatory responses or litigation), in addition to Portugal.

Only a few types of “tokens” can, indeed, be classified as a “currency”. Most others are either issued by an agent or fail the test of liquidity to be considered as a “means of exchange”. The paper breaks down, in particular, the conceptual case for “money” by examining the concept of money across jurisdictions, as a means of exchange, and for currency tokens, on example of Interbank Currency Tokens and Retail Currency Tokens.


My paper also considers the Utility Settlement Coin, The J.P. Morgan experiment, and Synthetic Hegemonic Currency as cases of Interbank Currency Tokens, as well as the Libra Association proposal, Monerium E-money, Central Bank Digital Currencies, USD Coin, Gemini dollar, Tether, TrueUSD, Paxos Gold and Maker/Dao, as examples of Retail Currency Tokens.

Under the heading “Messages, Communications, and Infrastructure”, I consider the infrastructure and the state of updates and synchronization within a distributed system in comparison to traditional payments infrastructure, as well as their governance issues. Besides the liquidity and governance conundrum, market and infrastructure integrity presents an example of the problem of decentralization and consequent lack of individual responsibility. Such arrangements invite the occurrence of the phenomenon described in the “Tragedy of the Commons” by Hardin, where individual users acting independently according to their own self-interest behave contrary to the common good of all users by depleting or spoiling that resource through their collective action.

Furthermore, in existing public infrastructure (i.e. for banking, telecommunications, and energy), the manager of the network is separated from the parties making transactions within the network. Additionally, some such managers may have market power (the nature of money implies network effects - the more agents use a currency, the more attractive it is as a means of payment - and a single currency may predominate in all exchanges) that can cause a natural monopoly.


The paper concludes that “smart contracts” are neither smart nor a contract and that network governance needs to be considered, in order to access its underlying legal framework. There is a need to go beyond the formal, descriptive representation (and dimensions) of a given entity. It is necessary to conduct an actual systematic approach, to access the function (rather than merely a formal representation) and governance of the blockchain infrastructure.

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