Introduced in earnest back in 2015 together with the launch of the Ethereum blockchain, smart contracts have often been hailed by enthusiasts as the decentralised future of deal-making. Technically, a smart contract is any piece of code that's deployed on a blockchain and executed when predetermined conditions are met, but most often this code describes an agreement between parties that involves funds being transferred from one wallet to another if a certain condition is met.
As technology evolves, the code of smart contracts becomes more sophisticated in order to describe the intricate and complex legal logic, which begs the question — are we moving towards a future, in which (most) legal tasks are solved by lines of code on a blockchain instead of human lawyers writing pages of barely comprehensible legalese?
We sat down with Dora Kadar, Nordic Assignee at KassaiLaw, to take a look at this question from the perspective of European law and business practices.
What's a smart contract anyway?
An often-used definition of a smart contract is a "collection of code and data (sometimes referred to as functions and state) that is deployed using cryptographically signed transactions on the blockchain network". Simply speaking, we're talking about a piece of code that will do its job no matter what happens, which ensures that the contract deployed this way can't be tampered with.
In addition to that, smart contracts offer high speed and efficiency of execution, and provide a trustless environment, in which the parties don't need to trust or even know each other to be sure that the terms of their agreements will be upheld.
"Among all kinds of smart contracts, we're looking closely at the subset of 'smart legal contracts,' which can perform a function similar to that of a legal agreement," said Dora. “The general consensus here is that in most European countries these contracts can likely be seen as legal agreements just like traditional contracts, with minimal tweaks and adjustments to the current legislation.”
The problems to solve
One major limitation of smart contracts that emerged early on was that in their pure form they had no access to information that was not on the blockchain. This limitation could be particularly important for legal smart contracts that tend to be connected to events happening in the real world. To overcome this issue, the concept of a blockchain oracle has been introduced to describe systems or networks that reach out to off-chain sources for information.
Although blockchain oracles come in all sorts of flavours, including so-called decentralised oracle networks (DONs), they still can be considered a single point of failure.
"No matter how well-protected and thought through those DONs are, they can't be considered part of the trustless paradigm blockchain relies on," Dora said. "At the end of the day, all parties signing a smart legal contract that involves a DON have to trust that the network will provide correct, unaltered information."
Another important aspect to think about is whether smart legal contracts are legally binding and therefore enforceable, even though in normal circumstances there appears to be no need to enforce such a contract (as it should execute automatically).
"Parties planning to enter into smart contracts have been asking us about this for a long time now," Dora said. "Since smart contracts are generally straightforward and objective (otherwise they would not work), I believe in most jurisdictions they are in fact legally binding, as there would be no trouble with their interpretations: there is always a clear offer, acceptance and consideration, which are the main elements in a binding agreement.”
“The challenges appear when there are additional formal requirements to a contract. For example, in case they need to be in written form, whether the code of a smart contract can be considered as written varies from jurisdiction to jurisdiction. What’s more, some contracts need to actually be on hard copy, countersigned by an attorney or notarised. When such formalities are required, under the current legislation, a smart contract would not be considered valid.”
"On the other hand, parties opt for smart contracts for many reasons, their decentralised nature being one. But when we talk about enforceability, binding nature and courts’ judgments, we’re essentially bringing in a centralised authority into an intentionally decentralised system. So it seems that there is still a demand to involve some form of legal certainty, legal mechanisms, some form of centralisation — and it will be the task of the upcoming years to resolve this contradiction."
Are the lawyers on the way out?
In 2021, the UK's Law Commission published a paper on smart legal contracts, concluding that "the current legal framework in England and Wales is clearly able to facilitate and support the use of smart legal contracts, without the need for statutory law reform". The paper also introduced a useful classification of those contracts into three main groups, depending on the text-to-code ratio: natural-language, hybrid, and code-only contracts.
This classification means — among other things — that in most cases it's still necessary to fully or partially define a smart contract's terms in natural language.
"Anything that cannot be put in a smart contract would be in the accompanying natural-language contract," Dora said. "Parties also need to think about whether putting any part of the contract into a smart contract fits their needs for that particular transaction. There are cases where a smart contract would only complicate things instead of helping, because of the nature of the transaction. For example, there could be too many complicated conditions, multiple services in the transaction; another possibility is simply that a big part of the transaction must remain confidential, which is contrary to the public nature of the blockchain. In such cases, parties should opt for a traditional contract."
As for code-only contracts, although they are much closer to the lawyerless utopia painted by blockchain enthusiasts, one of the big problems to solve there is liability. Cryptocurrency heists that exploited a vulnerability in smart contracts aren't unheard of — but would the developer who wrote the code be liable? Especially considering that non-technical people entering into the smart contract are at a total loss when it comes to understanding the code by which they are bound: non-programmers completely rely upon experts to explain the contract, which brings additional challenges and puts an even bigger emphasis on liability.
"Using the lawyer-analogy, smart contract programmers could become a regulated profession, and similar to lawyers, they could become obligated to take out liability insurance," Dora suggested.
At the end of the day, it appears like the main issues with implementing smart contracts in Europe have much less to do with regulation than with the technology itself and the way it fits with established business practices.
"Maybe with technology evolving, we will get further — but for now, lawyers are here to stay," Dora continued. "To begin with, we can help parties determine what would be the best contract structure for a particular transaction, and explain to them the potential risks such as security risks or risks about the objective nature of smart contracts that leave less room for negotiations, just to name a few."
Lead image: Sergio Capuzzimati
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