Smart Contracts and Blockchain Arbitration: Smart Solutions Paving the Way for a Better Dispute Resolution Mechanism


Introduction


Over the years, smart contracts have played a significant role in transforming blockchain technology, enabling a decentralised system. The World Economic Forum, in its 2015 survey recognised that by 2025-2027, about 10% of the global GDP would be stored in blockchains, owing to its efficient attributes of data security management. By the means of smart contracts, fully automated legal obligations can be enforced without the involvement of third parties. Much like conventional contracts, smart contracts on the blockchain are susceptible to a variety of problems, including non-transactional disputes, off-chain governance issues, and on-chain disputes. An on-chain dispute resolution system is still in its infancy. It is said that an on-chain smart contract is contained in a self-executing code that automatically executes the terms of the parties’ agreements without the intervention of a third party, leaving little space for human mistakes or disagreement. Smart contracts, on the other hand, do not eliminate the possibility of a disagreement. Thus, it becomes imperative to implement a dispute resolution mechanism governing digital relationships set out in such smart contracts.

 


Understanding Blockchain and Smart Contracts


According to the chamber of digital commerce, a smart contract is an instrument that executes underlying contractual terms. Smart contracts themselves are not the legal agreement — the agreement between the two parties is the contract, and the smart contract program simply executes the agreed-upon actions.[1] Smart contracts are like real contracts, but they are digital and are stored and executed on a blockchain. Blockchain is a particular type of distributed ledger technology (DLT), a way of recording and sharing data across multiple data stores where each has the same data records and is collectively maintained and controlled by a distributed network of computer servers called nodes.[2] A smart contract is a computer protocol intended to digitally facilitate, verify, or enforce the negotiation or performance of a contract allowing the performance of credible, trackable, and irreversible transactions without third parties. The contractual clauses are embedded as computer code in the blockchain. Smart contracts are simply programs stored on a blockchain that run when predetermined conditions are met. They typically are used to automate the execution of an agreement so that all participants can be immediately certain of the outcome, without an intermediary’s involvement or time loss.[3] Thus, the algorithms work something similar to an “artificial agent” in the context of the formation of a contract.


Legal Recognition of Smart Contracts


The prevalence of the following provisions conventions suggests widespread acceptance of contracts that are concluded and enforced digitally.

  • Article 2.1.1 of the UNIDROIT Principles of International Commercial Contracts, 2016 covers contracts involving automated performance arrangements, where parties agree on self-executing electronic platforms without the involvement of a natural person to ensure performance. [4]
  • Article 11 of the UNCITRAL Model Law on E-Commerce, 1996 states that an offer and the acceptance of an offer may be expressed by means of data messages, which shall not be denied legal validity and enforceability. Further, Article 2 clarifies that these “data messages” include not only communication exchanged electronically but also include computer-generated records that are not intended for communication.[5]
  • The UNCITRAL Model Law on Electronic Transferable Records, 2017 explicitly accommodated distributed ledger technology in its explanatory notes.[6]
  • The UNCITRAL Convention on Electronic Communications in International Contracts (2007 Convention) provides legal recognition to on-chain arbitrations. Articles 6 and 18 allow electronic data and transactions in arbitral proceedings.[7]
  • In the United States, many States have amended their versions of the Uniform Electronic Transactions Act (UETA) to address blockchain and smart contracts.[8]
  • On 18-11-2019, UK Jurisdictional Taskforce published a legal statement expressing the view that smart contracts were contracts under English law.[9]
  • On 28-5-2021, for the first time in blockchain arbitration history, Mexican courts enforced an arbitral award relying on a blockchain arbitration protocol (blockchain arbitral award). [10]
  • Recently, the High Court of England and Wales in Tulip Trading Ltd. Bitcoin Assn. for BSV[11] while considering whether security for costs could be satisfied by a party providing cryptocurrency refused the Bitcoin offered since it did not meet the required standards for security, however, allowed for other more sophisticated cryptocurrencies can be accepted at a later date.

Out of the available alternative dispute resolution mechanisms available, arbitration is the most accurate and optimal dispute resolution mechanism. The blockchain arbitration can be bifurcated into “on-chain” and “off-chain”.

  • On-chain arbitration involves the use of a smart contract in a classic dispute resolution mechanism.
  • Off-chain arbitration involves automatic recognition of awards but with automation of certain elements of the procedure before the Arbitral Tribunal.

Dispute Resolution Mechanism in Smart Contracts: Blockchain Arbitration


The on-chain arbitration process can be a desirable option from an efficiency perspective. A typical on-chain arbitration process is well envisioned in the Digital Dispute Resolution Rules (the “Digital DR Rules”)[12] published on 22-4-2021 after extensive public and private consultation with lawyers, technical experts and financial services and commercial parties by the UK Jurisdictional Taskforce (UKJT), that are to be used for and incorporated into on-chain digital relationships and smart contracts.

 

The Digital DR Rules define a smart contract as a digital asset. To incorporate these rules into a smart contract on a blockchain, the text “any dispute shall be resolved in accordance with UKJT Digital Dispute Resolution Rules” has to be included in an on-chain contract. The Digital DR Rules allow these words to be incorporated into codes. Since a blockchain is programmed into codes, these words can be incorporated intothe encoded form. Under the remit of the Digital DR Rules, disputes relating to smart contracts can be resolved without the interference of the courts. Disputes under the Digital DR Rules can be solved via an automatic dispute resolution process. Alternatively, such disputes can also be submitted to an arbitrator or expert determination.

 

  • Automatic dispute resolution process: The rules provide an idiosyncratic automated dispute resolution mechanism that allows the parties to choose a person, panel, or artificial intelligence agent to decide disputes automatically. The decision is then immediately applied to the digital asset system i.e. the platform where the digital asset exists. Rule 8 makes the outcome of the automatic dispute resolution process legally binding on the parties.
  • Submission to an arbitrator: Alternatively, any dispute between parties arising out of the relevant contract/digital asset that was not subject to an automatic dispute resolution process can be presented to an arbitrator. The procedure for commencement, appointment, and submission is quite similar to the regular arbitration procedure. The rules allow arbitrators to use a private key to implement their decision directly on the blockchain.

Recently in the fourth edition of the International Conference on Arbitration in the Era of Globalisation[13] held in Dubai, Justice D.Y. Chandrachud, Judge of the Supreme Court of India made reference to smart contracts in his speech to demonstrate the technological advancements in the sphere of commercial transactions and identified arbitration as the means to resolve disputes relating to smart contracts.

One of the most significant advantages of blockchain arbitration is that it removes human intervention, allowing for quicker and more cost-effective dispute settlement. On the blockchain, the proper examination of evidence may be done online, leaving less room for facts to be tampered with or evidence to be manipulated. However, smart contracts and blockchain arbitration, while gaining traction among governments and experts throughout the world, are still in their early stages of development and would require additional legislation to become a viable option for dispute settlement. Privacy concerns and the enforceability of smart awards continue to be a source of concern. Because blockchain arbitration is a component of technical evolution that allows artificial intelligence to generate self-enforcing decisions, it is still solar systems apart from being used in countries going through development.


† Managing Partner Advani Law LLP.
†† Senior Partner Advani Law LLP.
††† Associate Advani Law LLP.

[1] “Why Smart Contracts are Valid under Existing Law and do not Require Additional Authorization to be Enforceable”, Chamber of Digital Commerce, January 2018, <HERE>, accessed on 18-4-2022.

[2] Niki Wiles, The Radical Potential of Blockchain Technology, 6-6-2015, <HERE >.

[3] What are Smart Contracts on Blockchain?, (IBM), <HERE> accessed 10-4-2022.

[4] UNIDROIT Principles of International Commercial Contracts 2016, Art. 2.1.1, <HERE>.

[5] UNICITRAL Model Law Model Law on E-Commerce (adopted 21-6-1985), Art. 11, <HERE >.

[6] UNICITRAL Model Law on Electronic Transferable Records (adopted on 13-7-2017 by UNCITRAL), Art. 1, (Para 18, P. 23), <HERE>.

[7] United Nations Convention on the Use of Electronic Communications in International Contracts, P. 5, <HERE >.

[8] Uniform Electronic Transactions Act (UETA) adopted in 1999.

[9] UK Jurisdiction Taskforce, “Legal Statement on Cryptoassets and Smart Contracts”, November 2019, <HERE >.

[10] Maxime Chevalier, “Arbitration Tech Toolbox: Is a Mexican Court Decision the First Stone to Bridging the Blockchain Arbitral Order with National Legal Orders?”, Kluwer Arbitration Blog, 4-3-2022, <HERE > accessed on 18-4-2022.

[11] 2022 EWHC 141 (Ch).

[12] Digital Dispute Resolution Rules, 2021<HERE >.

[13] Dr D.Y. Chandrachud, International Conference: Arbitration in the Era of Globalization (4th Edn., Dubai, 19-3-2022).

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