Are smart contracts real contracts?

Last Sunday at 5:15 am UTC in block 709,632 the Bitcoin Blockchain was upgraded. The soft fork upgrade in the protocol, called Taproot, was the first in more than four years for the venerable blockchain. Ninety percent of minors agreed to switch to the new protocol months ago. Once locked, the waiting period for activation ended on November 14. At least one of the three Bitcoin Improvement Proposals (BIPs) including Taproot will enable more complex smart contracts within the Bitcoin blockchain system and some of the details of some of the more complex smart contracts will now be hidden from public blockchain viewers like Mempool. .

While smart contracts are often associated with the Ethereum blockchain and innovative implementations such as non-fungible tokens (NFTs) that are still of interest, they are also increasingly valuable in many other blockchain use cases. .

Bitcoin. Photo: courtesy

What exactly is a smart contract? Originally described in the 1990s by computer scientist and lawyer Nick Szabo, smart contracts can be more simply classified as digital vending machines. In a transaction through an ATM, two parties agree to exchange money for a product sold. Once the correct amount of money is inserted and the selection has been made, the vending machine must deliver the product sold; there is no option for anything other than specific market expected performance. Likewise, the code making up a smart contract represents a digital transaction between at least two parties, the execution of which is automatic when it is triggered by the terms of the agreement and in particular without any human intervention. While often triggered by external events, smart contracts themselves are not directly linked to the world outside of blockchain security and reliability, but instead use data flow oracles like ChainLink to determine whether Relevant execution events have occurred.

Smart contracts are an integral part of many emerging areas of blockchain technology including, but not limited to NFTs, DeFi (Decentralized Financial Applications) and DAOs, decentralized autonomous organizations. Smart contracts are typically unauthorized – open to anyone to participate – and even non-technical people can access the increasingly accessible technology as long as they pay the required amount of gas or blockchain transaction fees.

But are smart contracts real contracts or is the term inappropriate? To some extent, it will depend on the theories behind the contract.

Much of contract theory is straightforward and is often based, for example, on moral or economic theories. There are many theories about what underlies contracts, some even deserve Nobel Prizes.

In short, contracts are agreements between parties where they agree to one or more obligations, usually to perform or refrain from actions. More specifically, a contract is concluded between at least two parties who freely intend to enter into a legally enforceable exchange market. Here, at a minimum, the relationship between the parties includes an offer, an acceptance of the offer and the performance of the contracted obligation. Simple contracts that comply with these formalities are almost always enforceable with or without the contract being put in writing, although for more complicated and expensive contracts, the courts usually want something in writing. In fact, in many complex cases, negotiations and oral agreements are usually not binding per se, but the subsequent written agreement commemorating the negotiation and the agreement are.

Promises designed to encourage social obligations usually have social, but not legal, repercussions. The contract law apparatus is not intended simply to uphold social mores. However, with the exception of agreements entered into under duress or by fraud induced error (where mutual gain is lacking and exchange is ineffective), voluntary markets for counterparty-backed promises are almost always enforceable. More complicated are contracts that are not quid pro quo, such as free gifts, where only one party has obligations and promises. Here, these no-market deals are not necessarily enforceable, unless there is some sort of prejudicial remedy that is difficult to determine, at least under US law.

In addition, contract law does not always require a specific performance, in some cases the courts may prefer that the parties receive only the value of the case for the exchange. In these cases, breaking the terms of the contract is really beneficial when it can create more value and well-being in society; that is, an effective violation.

Contracts also often include informal self-help arrangements, such as guarantees or penalties for non-compliance. These are meant to make the possibility of contract performance more likely, but ultimately it is the knowledge that the court will enforce the contracts in the event of a breach that provides the most valuable security for the parties. contracting. Or at least, that was before smart contracts.

Because smart contracts find their application outside the scope of the courts, some have found it difficult to reconcile smart contracts with standard contractual theories.

Perhaps, however, smart contracts can promote a new contract theory that encompasses not only smart contracts, but other contracts as well. Perhaps smart contracts could fit better into a new contract theory that splits most contracts into two distinct and unequal components. The first is a voluntary transaction aimed at maximizing profit between two parties. The act of contracting creates a set of social, moral and legal obligations between these parties. Both the contracting parties and the law are interested in the relationship between the parties and because the negotiated performance must maximize the economic and social benefits not only for the contracting parties, but also for the society in general which can benefit from the positive externalities of the situation. contract. The nature of the law’s interactions with these obligations will ultimately depend on whether the fulfillment of the duties optimally creates the aforementioned social values, social welfare and profit maximization. In these cases, for example, if a party is in breach, there are judicial possibilities for redress which may modify the conditions or not be based on a specific performance.

The second element of some contracts, but not all, is the creation of a contractual obligation regarding only the physical good deals for the elements of the contract. In the case of inapplicable social contracts, or unrequited promises, you could argue that this second element is lacking and that these contracts are therefore difficult to enforce by the courts.

In this second component, there is a direct obligation, but this relationship lacks a human component and is absolutely only between the negotiated components, such as money and goods owed. There are no externalities that can ever be relevant. This obligation is secondary to the first, so policies that promote the first relationship, such as goodwill between companies or innocent mistakes, will prevail over policies that promote the second non-human relationship. As such, courts will not always require specific performance of the terms of a contract that contains both elements.

In the case of a smart contract, however, the first human component does not exist, only the cold and harsh second. As such, there can only be specific performance, nothing else matters or is relevant. We are not concerned with relationships, society or externalities. The only relationship that exists under the law are the unshakeable obligations between merchants. Here, unless there is an actual specific performance, there is no performance of the contract. All other performances that take into account morality, society and economics are irrelevant to this part of the transaction. So naturally the only thing that can happen in a smart contract is specific performance. Here, because the law has no other long-term interest in this contractual relationship, the law is not so interested in correcting errors or other problems and therefore exact execution is always required.

If this theory holds up, then maybe we can begin to understand why the law would seem to settle for smart contracts, despite all their shortcomings in classical contract law.

An interesting quirk of this theory: Intentional or unintentional, smart contracts, which will be greatly supported by the new taproot fork, are like its biological namesake: narrowly focused on one goal – the specific fulfillment of intended contractual obligations – rather than to try to be everywhere, as the alternative of the fibrous root system.

Professor Dov Greenbaum is Director of the Zvi Meitar Institute for Legal Implications of Emerging Technologies at Harry Radzyner Law School at Reichman University.


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