The rapid evolution of anonymous, autonomous, and distributed blockchain-based smart contracting creates friction and enforceability issues with existing legal and jurisdictional principles, calling the future governance of blockchain technology into question. The effective governance of blockchain technology and smart contracting is essential to ensuring its continuing evolution.

Because of its very expansive and near universal applicability, it is crucial for the broadening evolution of blockchain technology to find jurisdictional means for the governance of the crypto economy that is facilitated and sustained by blockchain technology. A lack of governance and conflict resolution mechanisms would undermine the democratized trust created by blockchain technology and hinder its broadening evolution and applicability.

Jurisdictional means are the basis for effective conflict resolution mechanisms applicable to crypto transactions in the blockchain. Not having the required jurisdictional means necessary for conflict resolution mechanisms for Ethereum blockchain-based smart contracting, may invoke consumer mistrust in the new technology. This can then undermine the evolution of the blockchain-based crypto economy.

Regulatory alternatives for blockchain-based conflict resolution are necessitated by the impossibility of consistently identifying the parties in any dispute in the context of crypto transactions on the blockchain and the associated problems of applying the existing legal infrastructure. It is very difficult if not impossible to conceptualize opportunities in the crypto transactional universe that could possibly enable and allow a court in the existing legal infrastructure to decide and enforce any disputes between crypto transactional parties.

Because of the severity of these challenges for the existing legal and jurisdictional infrastructure, the sensible approach for including good governance in crypto transactions necessitates instituting governance solutions inherent in the blockchain technology itself.

Lack of regulatory recognition

The lack of regulatory recognition of blockchain technology creates uncertainty for the blockchain community. The lacking recognition hinders the implementation of the technology across industries and undermines infrastructure conversion via blockchain technology. The regulatory uncertainty derives from insufficient or non-existent regulatory guidance, sparse court decisions, uncertainty over jurisdiction, and a sense in the user community of interacting in an environment that is generally free of law. As the technology applications grow and the value of cryptocurrencies rises, the evolution of blockchain-based crypto economy will depend to some extent on users’ trust in the efficacy of blockchain-based dispute resolution mechanisms and the immutability of the technology.

Courts have not yet recognized blockchain technology or addressed legal implications of blockchain-based applications. For the most part, the technology industry agrees that blockchain technology is immutable and secure. However, a review of published court opinions suggests that no court has had to review, assess, or scrutinize the uses and applications of blockchain technology at the time of publication of this article, which creates uncertainty in how courts may perceive and treat blockchain technology.

Blockchain ledgers do not exist in a physical sense, and therefore have no specific location. The blockchain is distributed, meaning the nodes in any public blockchain network can be located all over the world. Arguably blockchain transactions can therefore be subject to the legislation of any given node in the network. However, the nodes themselves are autonomously run, extremely redundant, and may be anonymized with encrypting protocols.

Therefore, the infrastructure does not fall under any traditional jurisdiction, but the users of the infrastructure also naturally evade any sense of traditional jurisdiction. All parties may transact entirely anonymously on a public blockchain.

Anonymity of blockchain transactions

The lack of identifiable parties in crypto transactions creates a distinct separation between real world and crypto transactions that has lasting implications for the application of existing jurisdictional principles. Every user on a public blockchain is anonymized by the use of public-key encrypted identities. The tandem use of virtual private networks (VPNs) can then prevent the identification of the parties to a smart contract.

Without identifiable parties, jurisdictional principles such as subject matter jurisdiction, personal jurisdiction, diversity jurisdiction, and federal question jurisdiction become irrelevant. To illustrate this point, proving personal jurisdiction by means of (1) physical presence, (2) domicile/place of business, (3) consent and (4) minimum contacts becomes impossible as none of these elements are known of the parties in a smart contract.

Physical presence is anonymous, as is domicile, consent and minimum contacts. Subject-matter jurisdiction, e.g. a given court can exercise power over a claim that the laws of the jurisdiction authorize such court to hear, is inapplicable because no given law would be able to authorize such power. But even if a given state or even the federal government were to pass a law that would grant such authority to a court, it is hard to see how the court would in fact exercise such authority, short of limiting access to the internet itself.

Not all smart contracts are fully anonymous and untouchable by traditional jurisdictional means. Some smart contracts will not automatically anonymize the parties because there is a physical element to such a consumer contract. For example, a powerful traditional corporation may wish to execute a complicated, non-hostile takeover of another company.

The transparent, public and perfectly logical structure of a smart contract could theoretically improve communication in such a negotiation. Other smart service contracts can be completely anonymous. For instance, a service contract involving services pertaining to cyberspace, such as programming services to create a given webpage, will be completely anonymous. It is important to note that as the technology becomes more widely accepted, such service contracts are going to become a highly important part of any given economy.
Even outside of cyberspace services, it is clearly possible that bounties for anonymous work executed via smart contracts will make traditional service contracts that require personal knowledge and physical appearance unnecessary. A bounty contract for anonymous work allows an anonymous person to put a bounty on a given job and offer such job on an anonymous smart contracting network to an anonymous counterparty. The contract acceptance and performance is dictated to some extent by reputational factors that link the counterparty and the performance under the contract.

Enforcement of smart contracts

The enforcement of smart contracts with traditional legal means is limited. First, disputing a smart contract with traditional means (in court, arbitration, mediation, etc.) is only marginally possible because of the aforementioned anonymity in blockchain transactions. Moreover, while smart contracts are coded as self-executing contracts, they do not necessarily provide effective mechanisms for enforcement if one party breaches his or her obligations in the smart contract. Semantically it could be argued that breach of a smart contract is not technically possible: the contract is entirely coded with mathematical logic and simply will not execute if a parameter is not fulfilled.

The literature is split on remedies for breaches of smart contracts. Some argue that because the smart contract replaces the existing legal contract in some circumstances, the smart contract will be governed by the same legal principles as the existing legal contract. Others argue that the breaching party may not live in an area where the courts have jurisdiction, thus the breaching party cannot be liable. In that case, assuming the operator knows identities of contracting parties, the operator of the blockchain platform should have a legal obligation to identify who the breaching party was and serve as the counterparty in a dispute scenario. These experts argue the operator of the blockchain should establish governing rules of the blockchain and specifications for dispute resolution. However, these specifications would have to be disclosed upfront and agreed upon by the parties to the smart contract in order to be enforceable.

Courts may be substantially challenged in interpreting smart contracts. Unlike the interpretation of a contractual dispute in the existing legal infrastructure where courts will assess what the contentious language in a given contract may mean to a reasonable human observer, smart contracts are not coded for a human observer. Rather they are intended for computer programming in a network of nodes (and in the future for artificial intelligence). To the extent that consumers are using smart contracts, the human element may be increased via the coding of graphical user interfaces. The basic premise of smart contracting remains emphasized on computer programming (and in the future artificial intelligence) not human interaction. Because of the emphasis on code for computer programming (and artificial intelligence), courts may not be able to hypothesize a reasonable human’s interpretation of a given smart contract. Courts may also be limited in their ability to consult programmers to interpret the coded language at issue in a given case because the meaning and logical reasoning of coded language is substantially different from human language.

From an evidentiary perspective, it is unclear who would own smart contracting blockchain contributions and whether there would be any applicable protections, such as work product or confidentiality. Without ownership rights for a blockchain transaction, it is also unclear who would be able to claim privileged information or how discovery would operate via existing laws. However, when the parties to a smart contract choose to reveal their identities, arguably privileged information or discovery laws should apply as if it was a written contract despite the fact that the contract was written in code.

Contract law remedies may not apply to smart contracts which raises possible enforceability issues. If a transaction in a smart contract fails to be completed or is partially completed but not added to the blockchain, it is unclear how liability will be allocated if those eventualities have not been accounted for in applicable code. Because of the blockchain’s decentralized nature, it is unclear who or what is accountable and could require regulation. Without solutions for those issues, liability for failed transactions or conflicts between parties have little guidance as to being resolved.

SHARE
Previous articleFeeling the heat
Next articleShifting the center of main interest
Wulf A. Kaal

Wulf Kaal is a tenured associate professor of law at the University of St. Thomas School of Law in downtown Minneapolis. He is a leading expert on hedge fund regulation in the United States and the European Union.  Before entering the academy, Kaal worked for Cravath, Swaine & Moore LLP in New York and Goldman Sachs in London.  Kaal has published more than two dozen articles in the United States and Europe. His articles were published in leading peer reviewed law and finance journals and in American law reviews such as the Minnesota Law Review, the Washington & Lee Law Review, and the Wake Forest Law Review, among others.  Kaal’s study on the effects of hedge fund registration requirements under Title IV of the Dodd-Frank Act has gained national attention and was covered in a Business Week article and other journals. He is the author of a book chapter on Investment Advisers and Investment Companies in the Securities Law Handbook published by Edward Elgar.
He has also been a consultant to major corporations and hedge funds regarding various aspects of financial markets and regulation.

 Wulf A. Kaal
Associate Professor
University of St. Thomas School of Law
1000 LaSalle Avenue
MSL 400
Minneapolis, MN 55403
United States
 

T: +1 (312) 810-4390            
E[email protected]   
W: wulfkaal