It seems clear that technological progress and its adaptation to business and social relations are moving at a faster rate than the capacity of the lawmaker to provide a proper legal framework in this area. There are two clear examples of this situation: the management of cryptocurrency, and “Blockchains”, which are closely linked to cryptocurrency.
The Blockchain system is based upon the confidence and consensus generated by a network of computers which manage a data base of enormous proportions.
The Blockchains may be public, if they are open to anyone, or otherwise closed, if their access is restricted to certain persons. Essentially, it is a matter of a decentralised system, not controlled by a single regulator, where the connected computers usually perform jointly, controlling the system. The system is controlled by software common to all users, a language which allows communication between connected computers.
The rules of operation of the system are protected by way of cryptography, or the use of algorithms, which do not allow manipulation and guarantee the absence of disruptive or false information in the Blockchain. The database is fed by the operations or registers that each user carries out there within, so that it is always under constant change and expansion, in a transversal and de-hierarchised manner. The common protocol used by all computers united in the system likewise allows the irreversibility of operations carried out in the Blockchain and their theoretic inviolability.
Given that the register Blocks which store the database merge together successively, without intermediary and under conditions of unchangeability (thanks to cryptography), it means the operations verified by the system do not need an intermediary to validate them, which has important consequences in legal and business systems.
But, why are Blockchains so important? One direct consequence of the use of Blockchains in mass is the disappearance of intermediaries in diverse areas of business traffic. For example, in the financial system, direct communication in Blocks in making payments and collections between individual means two things: eliminating the intermediary who verifies the existence of funds in the account of the payer, and secondly, making the operation effective almost immediately. This may mean the end of SWIFT transfers and even intermediaries in payments made with cards. The same may happen in credit operations, where the agility of the system would allow agents other than the conventional financial institutions to compete with the latter. Therefore, it is expected that the banking industry launches new brands to operate in parallel with its traditional business, in order to compete with the new agents who use Blockchains as a working method.
One of the applications of Blockchains are “Smart contracts”, that is to say, a digital agreement between parties, susceptible to self-execution, so that when a series of well-defined parameters are complied with (we shall call them conditions), a consequence is generated. Thus, when introducing certain data in the application, such as the wish to contract a specific service, the system shall register the conditions consigned by the contracting party and the system shall execute the agreement taking the data of the contracting party; and upon the occurrence of certain conditions, the system shall automatically execute the consequence derived from executing what was agreed, such as the payment of a settlement or compensation etc. However, what seems simple in the eyes of a computer technician will produce legal consequences, given that the circumstances and the facts that arise may be ambiguous or not exactly match the established parameters introduced in the system. For example, the delay in the delivery of a parcel may give rise to compensation, but is payment appropriate if the delay is for an unclear reason, that may not be explicitly attributable to the transport company? In this case, the computer system shall execute what it is able to discern, although this may produce a legal wrong.
Smart Contracts imply the intervention of a technological third party in the structure of the creation and expression of the contracting parties. We could refer to them as a “digital” expression of a concurrence of wills articulated in a computer code format and accepted by the contracting parties as a binding vehicle. The computer programme is fed by the data provided by the parties and automatically executes the contract accordingly, acting as an arbitrator responsible for giving each of the parties what has been agreed in the agreement. However, for this to happen, legal terminology much be transposed into computer terminology in a very precise manner, so that the computerised or robotic system of execution of the contract is in line with the reality of the will of the parties and a distorted or simplified interpretation does not come about because of failings in the computer language. As we know, a considerable misalignment between both languages is often found to exist.
Apart from computer articulation, the Smart Contract must fulfil the minimum conditions which characterise the legal institution of the contract: object, consent and purpose. A decentralised system may cause legal problems regarding object, but it is logical that the system itself is capable of identifying whether the object of the agreement falls within legal trade or not, at least for relatively simple operations. On the other hand, will conditions precedent or resolutive conditions of a Smart Contract be valid? The answer should be no, but who controls the system? What is the applicable jurisdiction when the parties have not agreed anything in this respect?
Other questions raised are the necessary identification of the contracting parties in order to avoid impersonation fraud, or rather verification of the registers introduced in the transaction. In parallel, the questions regarding the legal validity of contracting between computers and operations carried out without the direct intervention of a person must be dealt with. These are important issues regarding legal security, especially relevant when a Smart Contract is used within a public Blockchain. The solution to these challenges could lie in technology itself, which may offer applications capable of filtering data and verifying their authenticity before they become an unchangeable register.
Although prior cases of the use of Smart Contracts in business traffic already exist, mass use will expose the defects of the system and call for the fine tuning of the technical resources which allow the agents in the market to trust this type of contractual expression. Likewise, we cannot rule out that with the accumulation of millions of experiences, duly processed analytically, the Smart Contract system takes us into the future with a robotic formula for the resolution of certain contractual conflicts, based upon a digital arbitrator, mutually accepted by the parties, which will act in accordance with analysis systems generated by artificial intelligence.
Eduardo Vilá
Vilá Abogados
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22nd of December, 2017
