Smart Contract: Legal Perspective

A Smart Contract is a computer program that runs on a blockchain and automates the management of digital agreements. The terms of the contract are encoded in the program and executed without the need for intermediaries.

From a legal and juridical view, a smart contract is an automated digital agreement that is executed securely, transparently and reliably without the need for intermediaries. However, its legal status and enforceability vary by jurisdiction and are still under debate in many countries. In general, they still lack a clear and uniform legal framework and their validation and enforcement can be challenging from a legal perspective.

Blockchain transaction example

The following is a description of the processes that maintain security and trust in the blockchain system, through a practical example.

1. A transaction is requested. → Ana wants to send 10 Bitcoin to Bob.

2. The transaction needs to be authenticated using a public-private key pair. Each participant has a key pair, the private one is secret, and the public one is shared with the rest. A transaction is encrypted with a private key and can only be accessed by the receiver with the corresponding public key, acting as a digital signature. This step, independent of the existence of the blockchain, ensures that the transaction to be included later in the chain is correct.

3. The transaction must be validated. This is where the blockchain really comes into play. The rest of the nodes check that Ana has the amount of Bitcoins she claims to have and, through a consensus algorithm, vote on the validity of that block, to be included in a new block.

Smart Contacts Automations

Smart Contracts, being digital contracts expressed in the form of computer code that can be executed automatically when a series of conditions are met, allow automating all kinds of actions, not only transfers. Some direct actions are:

• Transfer funds: they can automatically transfer funds to a given address if certain previously established conditions are met.
• Contract execution: They can automatically execute contracts once certain conditions are met.
• Controlled access to information and resources: They can control access to information and resources, allowing access only to authorized parties.
• Data validation: They can validate data and records on a blockchain securely and reliably.
• Token issuance: They can issue tokens and manage their distribution and circulation.
• Rules of the game: They can automate decentralized applications according to previously defined rules.

Contract Code and Legal Contract

The smart contract code and the smart legal contract are two different concepts that relate to digital contracts in a blockchain.

1. Smart Contract Code: It is the code that defines the behaviour and rules of a smart contract in a blockchain. This code is written in a programming language compatible with the blockchain and is responsible for executing the specific actions of the contract autonomously once certain previously established conditions are met.
2. Smart Legal Contract: This is a legal contract that is formalized in a digital format and executed on a blockchain. This contract is based on applicable laws and regulations and is binding on the parties involved. The smart legal contract is used to record legal and commercial agreements in a secure, transparent and reliable manner.

In short, the smart contract code is the code that defines the technical functionality of a smart contract, while the smart legal contract is a formal, legally binding agreement formalized in a digital format and executed on a blockchain.

Discovering Smart Legal Contracts

As mentioned, a Smart Legal Contract is a legal contract formalized in a digital format and executed on a blockchain. These contracts are based on applicable laws and regulations and are binding on the parties involved.

A smart legal contract combines blockchain technology with law and regulation, enabling the formalization of legal agreements in a secure, transparent and reliable manner. By employing a blockchain, the immutability, and integrity of records and the elimination of unnecessary intermediaries are guaranteed.

The smart legal contract is used to record legal and commercial agreements on a blockchain, including purchase and sale contracts, lease agreements, employment contracts, and investment agreements, among others. By making use of a smart legal contract, the parties involved can ensure that agreed terms are met, and specific actions are executed automatically and without the need for intermediation.

In short, a smart legal contract is an innovative technological tool that allows the formalization of legal agreements in a secure, transparent and reliable way on a blockchain.

Challenges in the implementation of Smart Legal Contracts

• Interpretation: Like traditional contracts, a Smart Legal Contract is based on an offer and an acceptance between two parties involved. However, the interpretation of smart legal contracts can be challenging due to the autonomous and self-directed nature of code-based contracts. There can be uncertainty about how terms and clauses should be interpreted in the context of a stand-alone contract.
• Understanding: Understanding smart legal contracts and how they work can be difficult for some people, especially those without technical expertise. This can hinder their adoption and long-term use. In order for these contracts to have legal validity in the traditional sense (under the protection of state courts), not only must both parties be able to understand and interpret the code, but a court must also be able to do so, in order to settle potential disputes.
• Contract clauses
  • Operational: Easy to transcribe into code, straightforward and without interpretation. They describe how a contract will be performed and what actions must be taken to fulfill the obligations set out in the contract. These clauses are essential to ensure that the contract is effectively executed and that the obligations are fulfilled. E.g. When you pay a certain amount, you receive a certain product.
  • Non-operational: Not so easy to transcribe in code. Long sentences with ambiguous terms and legal jargon. They depend on the interpretation of an agent such as a judge or a lawyer. They describe the rights, obligations, and responsibilities of the parties involved in the contract, but do not describe how they are to be performed. These clauses may include terms about ownership, confidentiality, privacy, and other relevant legal issues. Specialists in this area are needed to perform the transcription. E.g., good faith, reasonable time, fitness for use….
• Immutability: The contract is immutable in the blockchain. It can be a challenge, especially in situations where a change or modification to the contract is required. All possible circumstances that may occur must be foreseen from the beginning, which is sometimes impossible, especially in long-term contracts.
• Traditional laws not adapted: The law is not ready (yet), it needs to be updated. Traditional laws may not be adequate to address the challenges and concerns related to smart legal contracts, which may lead to uncertainty and lack of clarity in their application. Creating a potential loss of protection by institutions, when there are conflicts between both parties.
• Absence of liability: Whose responsibility is it if a technical failure occurs: the programmer who made it, the parties involved, or the expert who supervised? Absence of centralization may also imply absence of legal liability.
• Limited to the blockchain: In situations where interaction with entities or systems outside the network is required, it is necessary to use systems called “Oracles”, which make it possible to connect the blockchain with the real world.

Some legal initiatives

European Regulation on Marken in Crypto Assets (MiCA)

MiCA is a regulation proposed by the European Union to regulate the crypto assets market. The regulation seeks to establish a legal framework for crypto assets and provide clarity and certainty to investors and market participants. MiCA addresses issues such as supervision, authorization, transparency, and investor protection. The regulation also establishes a clear definition of crypto assets, including cryptocurrencies, tokens and similar digital assets. The implementation of the MiCA regulation will have a significant impact on the crypto assets market in the European Union and on the way crypto assets are regulated and supervised in the region.

Civil Code and Smart Contracts

Both France and the United States have begun to regulate smart contracts. However, the freedom of form enshrined in the Civil Code of some countries, including Spain, implies that if they comply with the general requirements for contracts, smart contracts can be considered legally binding electronic agreements. For the time being, no specific regulation or ordinance on smart contracts has been established in Spain, but a new definition of writing in the Belgian civil code is under consideration.

European Legislation Identifier (ELI)

ELI is a European standard for identifying and describing the regulations published in official journals and databases. It was adopted in 2012 by the countries and institutions of the European Union with the aim of facilitating access, exchange, and interconnection of legal information. ELI provides online access to legislation in a standardized format, so that it can be located, exchanged and reused across borders. This ensures that citizens and legal professionals have better access to information on legislation, whether at regional, national, or EU level. The European Union has been exploring the use of smart contract technology in the Digital Single Market, through a “law plus technology” approach.

Solution: Dual contracts.

The combination of Smart Contract code and natural language contract allows for greater clarity and transparency in defining the obligations and responsibilities of the parties involved in a digital contract. Natural language is used to establish the context and general conditions of the agreement, while Smart Contract code is responsible for automating the execution of the specific conditions agreed upon. This combination allows for greater efficiency and security in digital contract management.

There are two common types of combination between the Smart Contract code and the natural language contract are:

1. Mirrored: This type of combination involves the creation of a Smart Contract that is a direct reflection of the natural language contract. The Smart Contract code includes all the clauses and terms of the written contract, and the parties can interact with the Smart Contract to fulfill the obligations set forth in the contract.
2. Hybrid: This type of combination involves the creation of a Smart Contract that combines elements of both the code and the written natural language contract. The natural language contract sets out the general terms and conditions, while the Smart Contract code is used to automate specific tasks and processes. This approach combines the efficiency and security of Smart Contracts with the flexibility and clarity of natural language.