Turkish Law Blog

Discussion of Smart Contracts in the view of PECL

Barışcan Kunduracılar Barışcan Kunduracılar/ Tilburg University
06 August, 2019
166

In 1996, an American cryptographer and legal scholar, Nick Szabo defined smart contracts as;

New institutions and new ways to formalize the relationships that make up these institutions are now made possible by the digital revolution. I call these new contracts "smart" because they are far more functional than their inanimate paper-based ancestors. No use of artificial intelligence is implied. A smart contract is a set of promises, specified in digital form, including protocols within which the parties perform on these promises” [1].

In other words, smart contracts are computer protocols that set the promises and execute and, enforce these promises automatically. Basically, smart contracts work by “if…then…” principle; if a condition met, then the smart contract is triggered and complete the transaction. Conditions can be verified by the smart contract automatically. For instance; imagine a smart contract about insurance between insurance company A and farmer B. Conditions are if the farm of B is damaged because of the flood, A shall pay B’s loss. When the flood occurred, smart contract self-verifies this situation by using “Internet of Things” and self-executes the payment term.

Smart contracts have escrow ability. This feature means, buyer’s digital assets, such as cryptocurrencies, are held by the smart contract. When the smart contract is triggered, the assets are transferred to the seller. Also, this ability provides convenience in terms of penalty clauses. If the seller infractions the terms and the conditions of smart contract, the smart contract applies the penalty clause automatically. For example, A is a logistic company and make a deal with B. They agreed on the transportation of the goods shall be done in 15 days. If there is a delay, the agreed price in the contract is decreasing automatically.

Smart contracts are stored in the blockchain. Blockchain is a dataset which consists of encrypted blocks. Blocks are chained each other with unique digital signatures; these unique digital signatures are generated by the cryptographic hash function. Hashing can be defined as a converting any string of inputs into unique 64-digit string output. Smart contracts can be timestamped when they enter into the blockchain. Timestamp means that data has been stamped by electronic signature by the electronic certificate service provider in order to determine when an electronic data is generated, changed, sent, received and/or recorded. A timestamp shows that the blocks which constitute the same blockchain are linked with each other chronologically.  Besides to timestamp provide immutable ability, it shows that a data existed before the specific time and status[2]. As a natural outcome of blockchain technology, once a smart contract enters into the blockchain, it cannot be modified or terminated. Smart contracts are secure in the blockchain. However, this immutable nature harms the legal status of smart contracts. This issue is explained later.

After a short explanation about smart contracts, what is a smart contract mean in a legal sense? On the contrary of the name, smart contracts are not contracted, they are executing tools of an agreement.

At first view, smart contracts seem like a contract. According to Principles of European Contract Law Article 2:101, two elements are required for concluding a contract; intentions of the parties and reaching a sufficient agreement. Parties have an intent to enter an agreement which is drafted as a smart contract, and the intention of the parties can be understood from the smart contract. “Reaching sufficient agreement” means an agreement that the terms and the conditions have been sufficiently defined by the parties[3]. This principle should be thought broader. For instance, in a vehicle sale contract, the vehicle, the price and the identities of the parties should be determined without any further requirement. The subject of the agreement and the price can be determinable from the smart contracts. However, it cannot be said for the identities of the parties. In the blockchain, individuals can create more than one digital identities. This issue harms the stability of identification. It is not always possible to know whom to sue for the individuals for disputes which occur from the smart contract. Also, the party’s intention can be changed by the counter-party in specific agreements. Identification is one of the most significant obstacles for the legality of smart contracts.

Parties have to be free to modify or terminate the contract, the clauses about preventing modification, and the termination is void. However, once a smart contract enters into the blockchain, it cannot be changed or deleted. It comes from blockchain immutable ability. I am going to explain these issues separately.

Modification of a smart contract is not possible in theory. However, it is possible in practical term; parties can use intermediary contract. The intermediary contract will hold the address of the active smart contract. Thus all the calls and process will be forwarded to intermediary smart contract with delegate call function. By this mean, the parties can continue to use the same address, but execution will be different[4].  Theoretically, modification of a smart contract is not possible, but practically it is possible with using intermediary smart contract.   

Termination of a smart contract is possible by the way that told above. However, it is not possible unilaterally. Parties shall be free to terminate the contract, this right cannot be restrained. Because of the immutable nature of the blockchain, data cannot be changed or deleted. The lack of unilateral termination right of the parties harms the legality of smart contracts in contractual law sense.

The other problem is about the “causa”. This principle exists in civil law[5]. Causa means a contract cannot exist without a lawful causa[6]. Smart contracts can be drafted for illegal purposes. For instance, a drug dealer can sell weed via blockchain. Third-parties, such as courts can not intervene in this smart contract. If the court finds a smart contract illegal, there is no way to stop that transaction by the court, only the parties can terminate it by delegate call function.

I think a smart contract is legally enforceable if it is based on a traditional contract and give a reference to the smart contract. Otherwise, legal problems can occur from the smart contract. The legal framework is not sufficient for this technology, the lawmakers shall regulate blockchain law and define the smart contract in the legal sense.

At the end of my research, I want to discuss the proof ability of a smart contract. As discussed before, they are not contracts. Article 2:101/2 of the Principles of European Contract Law says “A contract need not be concluded or evidenced in writing, nor is it subject to any other requirement as to form. The contract may be proved by any means, including witnesses”. The literal of the Article is obvious; existing of a contract can be proved by any means. Smart contracts can be used to proving the existence of a contract if any dispute occurs.


[1] Nick Szabo, Smart Contracts: Building Blocks for Digital Market, 1996

[2] Blockchain Expert, Blockchain Timestamp and Document Verification, 15 March 2019, < https://www.blockchainexpert.uk/blog/blockchain-timestamp-and-document-verification> , accessed 27 July 2019

[3] W.M. Shrama, The Principles of European Contract Law and Dutch Law, Kluwer Law International, 2002, page 83

[4] Merunas Grincalaitis, Can a Smart Contract be upgraded/modified? Is CPU mining even worth the Ether? The Top questions answered here…, 6 February 2018, Section 6< https://medium.com/ethereum-developers/can-a-smart-contract-be-upgraded-modified-1393e9b507a> , accessed 29 July 2019

[5] Çağdaş Evrim Ergün, AÜHF 2004, SÖZLEŞMELER  HUKUKUNDA CONSIDERATION/SÖZLEŞMEYLE  BAĞLANMA NİYETİ KAVRAMI  VE CAUSA/HUKUKİ  NEDEN  İLE İŞLEVSEL DENKLİĞİ  MESELESİ, 2004

[6] Caslav Pejovic, Civil Law and Common Law; Two Different Paths to Leading to Same Goal, July 2001, < https://www.researchgate.net/publication/265244573_Civil_law_and_common_law_Two_different_paths_leading_to_the_same_goal> , accessed 29 July 2019

 

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