The Law of Smart Contracts
What is blockchain? Why is it important? What on earth is going on?
As these questions loom large, it is apt to provide a succinct answer as a point of departure: A blockchain is a distributed ledger of transactions in the form of data arranged into blocks that are linked by cryptographic links. Each of these blocks references a preceding block through a mathematical function known as a hash: This creates an unbreakable chain, i.e., a blockchain. It was developed to facilitate transactions in Bitcoin - a decentralized digital currency founded by a person or a group pseudonymously known as Satoshi Nakamoto within the fintech industry.
Back to the explaination, and the nitty-gritty parts: Untypical of transactions regulated by centralised financial institutions, blockchain transactions are distributed and maintained by multiple computers referred to as nodes. Nodes compete to immutably validate the newest block entries before the other nodes to gain rewards: This is called mining. In this process, the validated blocks are preserved forever and cannot be deleted ex post facto. As its description, a distributed ledger, alludes, any person who utilises the network has access to the ledger and can see the most recent transactions. In order to determine which block gets added to the chain, consensus should be reached by the nodes.
That’s it.
Figure 1: An illustration of centralised, decentralised and distributed transaction registries.
The implications of this technology have been far reaching, with developers using it to create markets, store real estate registries, execute testamentary bequests and enforce contracts among other innovations. In this article, the smart contract will be the main focus. On a blockchain platform, sui generis contracts can be created and these contracts are self-executing.
Of equal importance are the digital tokens or coins which are used to encourage the validation of transactions. In Bitcoin, these are called BTC. However, since smart contracts are the subject of discussion, Ethereum will be used as an example hereafter. Like Bitcoin, Ethereum is based on blockchain technology and is distinguished by its smart contracts function. Within Ethereum, the coin can represent any fungible thing that is recognised in commerce, e.g., currency, reward points, and gift vouchers, etc. A smart contract was defined by Nick Szabo in his 1996 seminal work, “Smart Contracts: Building Blocks for Digital Markets,” as “a set of promises, specified in digital form, including protocols within which the parties perform on these promises.”
What does this mean? A code is written to the blockchain detailing clearly the terms of contract and the reciprocal obligations flowing from it. Once the terms of contract have been readily ascertained, the obligations are automatically enforced. The distributed ledger system contains all of the data and theoretically the capabilities necessary for the smart contract to execute autonomously. The required conditions are coded in the smart contract and once they are met, the contract obligations are automatically executed. This has various important implications for the principles of contract, namely:
1. Pacta sunt servanda
This principle literally means that agreements must be kept. In smart contracts, the agreements are effected automatically and thus a breach of the contract is avoided.
2. Privity
The idea that contracts create duties and rights only for the parties to the agreement, and third parties are excluded is enforced by smart contracts.
3. Possibility of performance
This principle means that the obligations created by the contract must be capable of performance. This issue is solved by smart contracts
Therefore, from this, it is clear that this a much needed innovation in our law of contracts since the normal principles which often lead to void contracts due to non-compliance are inherently guaranteed in the smart contract. In practice, however, there is still uncertainty regarding rescinding and repudiating such contracts and therefore the idea of consensus in a narrow sense still needs to be implemented into the blockchain
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