The ‘Code-as-Law’ Debate – An Introduction to Smart Legal Contracts (Part 1 of 2)
Disruptive technologies such as smart contracts are taking over the globe, becoming increasingly relevant in many transactions across different industries. As a result, some countries have started to develop their own legislation regarding smart contracts, causing fragmentation to the law. Furthermore, smart contracts themselves may also prove problematic due to their infancy, causing many unforeseeable aspects. This has left the international commercial law surrounding smart contracts mostly unsettled.
The term ‘smart contract’ represented the unification of two different areas of technological development: electronic contracting and cryptography. Clack et al. described them as ‘an automatable and enforceable agreement; automatable by computer, although some parts may require human input and control. Enforceable either by legal enforcement of rights and obligations or via tamper-proof execution of computer code’.
Smart contracts serve as a condition to execute orders that permit the administration of digital assets (tokens) and the encrypted data in the blocks of the chain. They are executed when an external agent (an oracle) to the chain intervenes by verifying a condition’s fulfilment. Once the oracle issues the command, the smart contract triggers a programmed digital event. This execution of smart legal contracts allows the virtual operators to show the consequences of the scheduled event, which is typically predetermined by a conclusion of a transaction.
Some problematic features of smart legal contracts are:
1. Conditional Framework and Immutability
In contract law and traditional contracts, promises are made in exchange for other promises. Conditional statements are also essential in smart contracts, which creates immutability and robustness. However, this is problematic as parties need to re-draft the entire contract incorporating the modification. On the contrary, parties can use modest resources to negotiate and execute that change in writing or verbal agreement in a traditional contract.
2. Certainty and Security
The certainty of smart contracts derives from their codification. This robustness varies with traditional contracts, where the requirement for nuance and interpretation is often present. However, it may be troublesome in undefined and subjective terms, such as ‘commercial reasonableness’ and ‘good faith’.
The anonymity of parties also poses a problem. Negotiation costs are lower when parties can imply, instead of expressly define shared trading norms. Such relationships can also provide a flexible and responsive foundation to transactions, encouraging parties to avoid disputes.
3. Efficiency and Cost
Smart contracts may be efficient by cutting the intermediary. However, other costs may arise. For example, highly complex transactions often require a highly precise ex-ante definition of adequate performance and extensive monitoring to ensure the agent’s honest and faithful performance. A contract as such will likely be expensive to draft and difficult to deploy.
Smart contracts are therefore not as perfect as some technologists may say. The above potential widespread use and problematic features of smart legal contracts implies a need for a regulatory framework. This sparked a debate in the legal community of whether software code is able to replace the role of the law and become the sole regulatory mechanism for the cyberspace.
By: Hendry Wong