The Legality of Smart Contracts

in hive-175254 •  4 years ago  (edited)

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The organizational theorist Arthur Stinchcombe once wrote that contracts are merely organizations in miniature, and by extension all organizations are just complexes of contracts.

Firms are created using a series of contractual agreements, ranging from employment contracts and employee benefits, to deals with vendors and suppliers and obligations to its customers, to building leases and sales & purchases of equipment.

Traditionally, these contractual obligations are quite costly because they need to be enforced externally by society in the form of a trusted legal system and through legal enforcement. Courts, lawyers, judges and investigators all form this system of contract enforcement. With a blockchain-based Smart contract, however, much of these costs are greatly reduced or eliminated. This promises to make blockchain-based organizations more efficient, cost-effective, and competitive compared to traditional firms in the marketplace.

All the above illustrates that “Smart” contracts go far beyond the existing models of contracting process and represent a new paradigm of interaction in a cyberspace. To illustrate this concept, it is necessary to provide some examples of potential application of “Smart” contracts in real life.“Smart” contracts allow to create pools of resources and to allocate them according to agreed criteria, what can be especially relevant for crowdfunding activities or for insurance-type of contracts. To bring some examples, Smart contract may track the amount of funds submitted to the crowdfunding project, and once it exceeds the necessary total, such amount is transferred to beneficiary. Otherwise, funds are returned back to the donors.

Another example. A group of farmers may agree to create a pool of resources as an insurance against the drought or flood or other natural disaster. Once such a disaster occurs, machine verifies it according to the specified procedure (e.g. by checking the weather or news in predesignated sources) and allocates resources. Needless to say, that Smart contract provides ultimate degree of transparency and auditability, mitigating the risks associated with intermediary’s decision-making process and “human factor” as well as with time delays. As an additional “bonus”, such payments occur seamlessly across the borders.

Some scholars argue, that Smart contracts are a form of self-help, because no recourse to a court is needed for the machine to execute the agreement. Self-help can be understood as “legally permissible conduct that individuals undertake in absence of the compulsion of law and without the assistance of a government official in efforts to prevent or remedy a civil wrong”. Such an approach, while having some merits, appears to be too simplistic, depriving Smart contract of deeper analysis within the framework of contract law and setting certain questions, worth of answering.

One of the postulates of Szabo's is that Smart contract can be regarded as a legally-binding agreement. First of all, it is used to govern relations associated with circulation of certain digital assets, thus intending to govern economic relations between the parties. Transfer of digital Blockchain-based asset from one person to another one is a typical subject matter of Smart contract and may qualify as a “legal effect”, being one of the constitutive elements of a contract.

Secondly, although Smart contract’s performance is automated, it still requires the presence of the will of the party to it in order to become effective. Such will is manifested at the moment when an individual decides to enter into such an agreement on the terms specified in advance, or, in case with electronic agents, – when individual decides to use such an agent for conclusion of certain agreements and agrees to be bound by their actions. The person expresses his consent with the terms of the contract and mode of their execution at the moment of conclusion of the contract. Taking into account that such person won’t be able to influence the execution of the agreement, once it is entered to, there should be a certain trust in place, which gives rise to a kind of “fiduciary” relations in Smart contract. But in contrast to classic contract where trust is put in the personality of the other party to the contract, in Smart contracts such trust is put in the computer algorithm standing behind the agreement (“trustless trust”). It is also possible to find offer and acceptance in the process of Smart contract formation.

If we take an example with crowdfunding Smart contract, its terms are predefined by the beneficiary (“offer”) and a person willing to donate to the project by transferring a certain asset to the pool is making an acceptance of that offer by its behavior. Whether or not there is an intent to create legal relations by the party’s to the “Smart”contract is a tricky question: it is possible to argue that by entering into a “Smart” contract they have an intention to use alternative regulatory system, not a classic contract law, thus there is no true intent to create legal relations. However, if the result is in fact the same in substance to the one, usually regulated by usual contracts - transfer of ownership over certain asset- then it may be argued that the nature of the relations in the core of it are also the same. Besides, “Smart” contracts don’t fall into a class of agreements, where legal contracts are not normally made (e.g. social invitations like invitation to dinner or family arrangements (e.g. a promise to wash the dishes).

Finally, the mere fact that the contract is concluded by electronic means does not mean that it is not a contract. The same is true for the contract that exists solely in cyberspace.

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