Smart Contracts: The Good, the Bad and the Ugly - Part 1: The Good (and a short history)

In this two part article Rachel Goss take a fresh look at the perennial question of whether smart contracts can ever work under English contract law by looking at the good, the bad and the ugly aspects associated with them. In Part 1 she provides a short history of smart contracts and a look at the good.

Over the past two decades, computers and digital platforms have risen to prominence in several different industries. Devices are becoming smarter, more advanced, and can automate the performance of countless tasks, the impact of which has been felt in business, social interactions and indeed contracting. The ability to contract online using agreements enshrined within software code has revolutionised the way parties conduct business. Yet such contracts are merely written agreements in digital costume – though electronic in form, their substance and execution remain reliant on humans.1 In recent years however, the emergence of an innovative technology has sparked interest in code-oriented contracts that can self-execute without the need for human intervention. This technology has been dubbed as a ‘smart contracts’ 2.

In this article I will look at blockchain-based smart contracts under the current UK contract law and whether they can be law or are merely machine. It is important to note that smart contracts can exist on centralised databases and are not exclusive to blockchain systems. The focus shall however be placed on blockchain based smart contracts because of the recent meteoric rise of blockchain technology in finance through bitcoin and cryptocurrencies. This rise in popularity helped renew interest in smart contracts so it seems fitting to place the focus on them. 

I’ll begin with a brief history of blockchain and smart contracts before addressing what they are and how they operate, before going on to identify and provide insight into what I’ll term the good, the bad and the ugly of smart contracts. The good details components of UK contract law that smart contracts could potentially improve alongside several other advantages. The bad shall provide insight into several problems caused by smart contracts and the disadvantages of their implementation. The ugly focuses on the grey areas associated with smart contracts. They remain a new development and consequently several issues exist including which laws should govern them and the jurisdiction that applies in a smart contract between two individuals residing in separate states. 

 Overall, the law cannot escape the effects of digitalisation and, although it may take some time, smart contracts are likely to see more widespread adoption for smaller contractual agreements and basic transactions over the next decade. However, they are not going to completely replace traditional contracts as they are expected to remain the dominant contracts for longer agreements. Instead, both will likely be adopted together and used to maximise the efficiency and performance of the UK contract law system. 

A Brief History of Smart Contracts

In 1991 the World Wide Web became accessible to the public for the first time sparking a period of mass internet expansion3. During this period, 2.8 million internet users in 1990 ascended rapidly to around 631 million in 2002.4 It was amidst this growth the term ‘smart contract’ was coined by cryptographer and legal scholar Nick Szabo in 1996.5 He defined them as a “set of promises, specified in digital form, including protocols within which the parties perform on these promises”6. Perhaps the most well-known example of an automated smart contract is the vending machine which “directly effectuates performance, by taking in money and dispensing products” and “incorporates enough security to make the cost of breach exceed the potential rewards”.7 Using the vending machine as a forerunner8, Szabo speculated that the digital revolution would alter the process of contracting: traditional contracts would cease to be employed with parties choosing to adopt smart contracts instead. Additionally, he believed that smart contracts would improve the execution of what he identified as the “four basic objectives of contract design”9: observability, verifiability, privity and enforceability. An improvement in the execution of these four objectives would, according to Szabo, significantly benefit contractual relationships on a global scale:

“Legal barriers are the most severe cost of doing business across many jurisdictions. Smart contracts can cut through this Gordian knot of jurisdictions. Where smart contracts can increase privity, they can decrease vulnerability to capricious jurisdictions. Where smart contracts can increase observability or verifiability, they can decrease dependence on these obscure legal codes and enforcement traditions.” 10

Szabo’s concept of fully automated contracts that would both ease and facilitate contracting across jurisdictions was, however, ahead of the times: the technology was not advanced enough to make smart contracts a reality.

Recently however, “with the growing adoption of Bitcoin and other blockchain-based systems, there has been a renewed interest, and increased experimentation, in transforming legal agreements into code”.11 Bitcoin was proposed in 2008 by an individual or group known only as Satoshi Nakamoto as an alleged response to the financial crisis that occurred within the same year. It is a: 

“decentralised, public ledger with no trusted third party possessing ultimate control. Anyone with Bitcoin can participate in the network and even hold a copy of this ledger if they want to. In that sense, the ledger is “trustless” and transparent.” 12

Bitcoin therefore enables “transactions directly between two or more parties, authenticated by mass collaboration and powered by collective self-interests, rather than by large corporations motivated by profit.”13 In short, it effectively cuts out the middleman and allows parties A and B to exchange digital currency without the need for a trusted intermediary such as a bank to interfere. Individuals no longer need to know with whom they are transacting – they put their trust in the code behind Bitcoin. Furthermore, every transaction is publicly available because anybody can, at any time, obtain an updated copy of the Bitcoin decentralised public ledger. This transparent, “trustless” nature is made possible by what is known as a blockchain.

Though “the technology is complicated and the word blockchain isn’t exactly sonorous, the main idea is simple. Blockchains enable us to send money directly and safely from me to you, without going through a bank”.14 A blockchain is therefore a distributed ledger upon which transactions are conducted, verified and subsequently recorded within a block that is linked to the preceding block consequently creating a chain.15 One particular blockchain, known as Ethereum, “adds another layer by allowing users to put code on its blockchain that executes automatically”16 which enables the creation of the smart contracts that Szabo theorised . Subsequently, there has been a renewed interest in the development of smart contracts due to the emergence of blockchain technology and much speculation regarding their potential to substantially impact the legal world. 

The Good 

Advocates of smart contracts often possess a view of “anything you can do, I can do better” in relation to traditional contracts. As a digital medium, it is undeniable that a smart contract can operate quicker, more effectively and without the need for human intervention. But does this mean that they can perform the function of a traditional contract in a manner that is vastly superior as purported by their advocates? There are several functions that  smart contracts appear  be well equipped for (for example AXA’s Fizzy, which automatically compensates people whose flight has been delayed by more than 2 hours), and they could potentially eradicate the possibility of non-performance amongst other common issues that arise during contractual relationships.  Yet other situations may arise which would require a contract in a more traditional medium (such as a written one) due to the nature of contractual relationships which “are not one-off transactions but are either long-term ventures…or at least represent one transaction forming part of an ongoing course of dealing between the parties.”18 Thus, to analyse whether current UK contract law can facilitate the use and application of smart contracts in their current form, one must examine the good, the bad, and the ugly aspects associated with them.

The Good

Smart contracts promise to be revolutionary once they overcome the initial hurdle of being adopted under the UK law of contract. Even in their current form however, they offer many benefits and potential solutions to common problems that arise in contractual relationships such as efficiency, fluidity (that is, the ease with which contractual obligations can be amended), and trust. 

Efficiency

There can be little doubt that when it comes to contracting, the parties are seeking to execute the agreement in a manner that will see the fulfilment of all contractual obligations alongside the absence of any factors that would delay or prevent completion. Performance within a contractual relationship can be impacted where a party refuses to, or cannot fulfil, their obligations resulting in a breach. With a smart contract however, the risk of non-performance is eradicated because they “don’t make enforcement easier – they make it unavoidable. They change the nature of the contract itself”19 from one that could be easily breached by a party to one in which, regardless of circumstances which arise outside the contract, performance is ensured. There would be “less of a need for parties to repeatedly check and monitor obligations embodied in a smart contract because a blockchain network would automatically execute the smart contract’s code”20 which would ultimately result in a lower volume of cases having to go to court.

Smart contracts may also reduce cases involving promissory estoppel. The doctrine states:

“If A has made a clear or unequivocal promise to B which has affected B’s position, and it would be inequitable to allow A to go back on such promise, then A will be prevented from acting inconsistently with the promise.” 

A would be estopped from acting in a manner that is contrary to the promise they made to B. Lord Neuberger best described the doctrine as “putting legal clothing on the adage that you should not lead people up the garden path”22. Within a smart contract, a party will not rely on what the other party has said following the initial process of putting the contract into motion because they would instead rely on the code to execute accordingly. Given that they are notoriously immutable, one could not reasonably believe that a statement made by another party after the implementation or execution of the smart contract was an offer of a new agreement. This potentially improves the efficiency of contracting as there can be no suspension of rights because of estoppel.

Fluidity

When a contract is formed, it ordinarily follows a lengthy period of negotiations between the parties during which they will agree upon the terms and obligations contained within it. Yet relationships are dynamic and ever changing, a factor that needs to be reflected within a contract. A condition that perhaps seemed optimal for a party at the beginning may now not work in the way they had hoped and thus may require revision. Where a traditional contract is concerned, the process of amending or redrafting contractual provisions could be limited by a variation clause included in the agreement that rendered any changes ineffective unless made in a medium agreed upon by the parties (typically changes were only allowed in writing to prevent informal oral variations to a contractual agreement). This position was changed in the case of Globe Motors Inc v TRW Lucas Variety Electric Steering Ltd23 which held that any clause intended to prevent a change in the provisions of the contract unless they were in writing would no longer be preventative against variation that occurred orally or through conduct. A contract can now be changed or amended provided there has been a valid agreement between both parties supported by a new form of consideration. The process of writing up this new agreement and establishing whether there has been sufficient consideration is normally time consuming. Furthermore, the change of the term itself may lead to dispute amongst the parties which ultimately delays the contracting process. This is in stark contrast to smart contracts which offer a greater fluidity to the parties and the potential to adapt to changes as they arise. 

Using an oracle (that is input from outside the contract used to determine if that test has passed or failed), the smart contract may be able to detect external changes or situations that could potentially impact the execution of the contract. It could “have allocated the risk in typical binary fashion of any deviation from the status quo and may have inserted some reference to an external arbiter of whether such deviation has occurred.”24 The allocation of risk is similar to an arbitration clause in a traditional contract yet the parties do not have to resolve the issue themselves: the code would automatically execute in a manner that considers the deviation that has occurred but nonetheless grants the same or a similar result. This is merely speculative at present, but it is nonetheless clear that a smart contract would offer a much more rapid variation solution to parties seeking to incorporate change quickly and effectively so as not to delay the contractual process. Though the code itself cannot be changed by human intervention due to the immutability of smart contracts, an oracle could feed the code certain information or data to prompt it to reconfigure thus making them a more dynamic method of contracting. Some have even proposed “self-driving contracts” in which “the parties set only broad ex ante objectives; but…the contract uses machine-driven analytics and artificial intelligence to translate the general ex ante objective into a specific term or directive at the time of performance”25. Though at present such contracts  may seem like something that could exist only in science fiction, “as technologies that allow for predictive accuracy and ubiquitous monitoring and communication advance, self-driving contracts will proliferate.”26 The same can be said regarding smart contracts: as technology continues to advance, the smarter they shall likely become. A self-executing arbitration clause therefore becomes significantly more plausible. 

Trust

In the words of author Tennessee Williams, “We have to distrust each other. It is our only defence against betrayal.”27 Though betrayal is perhaps too strongly worded, the message is clear: we, as individuals, are often mistrustful. A feature of smart contracts that promises to not only make contracting safer but facilitates contractual relationships without the need for a trusted intermediary, is the use of a trust mechanism. 

Traditionally, one would be cautious if they were entering into an agreement with a party they did not know and often those transacting online would simply refuse if the person seemed ‘dodgy’. Smart contracts remove the need for trust and in doing so remove the need for a middle man. Their resilience and the decreased risk of hacking or self-dealing behaviour, allows for new relationships between parties who but for this assurance would not enter into a contractual agreement with one another. Additionally, the certainty that the coded obligations will be automatically executed regardless of one’s intention means that one “need only to trust that the code accurately memorialises their intent and that the nodes responsible for maintaining the network will properly execute the smart contract code.”28 In short, trust is no longer needed between the parties provided they trust in the code. Smart contracts are ‘trustless’ which is arguably their greatest advantage as it allows contracting to occur between two parties without the need for a personal relationship to exist between them.


Rachel Goss is a Masters student at Queen’s University Belfast where she is researching the potential impact that emerging developments may have on contract, corporate and copyright law.

READ PART 2 HERE

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Footnotes

1 Kevin D. Werbach and Nicolas Cornell, ‘Contracts Ex Machina’ (2017) 67 Duke Law Journal, Available at https://ssrn.com/abstract=2936294  Accessed 30/11/17 

2 Nick Szabo, ‘Smart Contracts: Building Blocks for Digital Markets’ (1996), Available at http://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html Accessed 30/11/17

3 Martin Bryant, ‘20 Years Ago Today, the World Wide Web was born – TNW Insider’ (2006) https://thenextweb.com/insider/2011/08/06/20-years-ago-today-the-world-wide-web-opened-to-the-public/ Accessed 16/3/18

4 Worldmapper: ‘The World as You’ve Never Seen It Before – Communication Maps’ http://archive.worldmapper.org/textindex/text_communication.html Accessed 16/3/18

5 Nick Szabo, ‘Smart Contracts: Building Blocks for Digital Markets’ (1996) www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html  Accessed 3/12/17

6 ibid 

7 Kevin D. Werbach and Nicolas Cornell, ‘Contracts Ex Machina’ (2017) Accessed 30/11/17

8 Nick Szabo, ‘Smart Contracts: Building Blocks for Digital Markets’ (1996), Available at http://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html Accessed 30/11/17

9 ibid

10 ibid

11 Primavera Di Filippi and Aaron Wright, Blockchain and the Law (HUP 2018) 

12 CB Insights, ‘What is Blockchain Technology?’ (2017) https://www.cbinsights.com/research/what-is-blockchain-technology/ Accessed 19/1/18

13 Don and Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin is Changing Money, Business and the World (Penguin Random House UK 2016) p6

14 ibid 

15 Don and Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin is Changing Money, Business and the World (Penguin Random House UK 2016) p7

16 CB Insights, ‘What is Blockchain Technology?’ (2017) https://www.cbinsights.com/research/what-is-blockchain-technology/ Accessed 19/1/18

17 It is important to note that as stated in the introduction, smart contracts do not exclusively exist on blockchain applications and can also be implemented on a database that is stored in a central location (centralised database).

18 Janet O’Sullivan and Jonathan Hilliard, The Law of Contract (7th Edition, OUP 2016) p5
19 Kevin D. Werbach and Nicolas Cornell, ‘Contracts Ex Machina’ (2017) Accessed 30th Nov 2017

20 Primavera Di Filippi and Aaron Wright, Blockchain and the Law (HUP 2018) p81
21 Martin Hogg, Promises and Contract Law: Comparative Perspectives (CUP 2001) p181

22 Neuberger of Abbotsbury, ‘Thoughts on the Law of Equitable Estoppel’ (2010) 84 Australian LJ 225, 238
23 [2016] EWCA Civ 396

24 Antony Lewis, ‘Thoughts on Blockchain Technology’ (2016) Bits on Blocks, https://bitsonblocks.net/ Accessed 20/11/17
25 Anthony J. Casey and Anthony Niblett, ‘Self-Driving Contracts’ (2017) Journal of Corporation Law, Vol. 43 Issue 1, p 1-33

26 ibid

27 Tennessee Williams, Camino Real (Penguin Plays 1953)
28 Primavera Di Filippi and Aaron Wright, Blockchain and the Law (HUP 2018) p81

Published: 2019-06-13T15:00:00

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