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The journey to “Industry 4.0” not only brought technological advancements but also generated technical, philosophical, and legal questions and potential problems. Digital technology, blockchain, big data, and artificial intelligence have led to serious discussions in private law, even in commercial law, capital markets, and intellectual property law where there are preestablished and traditional rules. It has become more and more difficult for legislators and jurists to keep up and understand the advancements to prevent problems or find solutions. The slow evolution of law prevents reconciliation with new technology.
Blockchain is considered a part of this journey. The term blockchain constitutes three concepts, blockchain technology, blockchain software, and blockchain platform. It is defined as “a data structure that makes it possible to create a digital ledger of transactions and share it among a distributed network of computers.” [1] It uses cryptography to allow each participant on the network to manipulate the ledger securely without the need for a central authority. Without a central authority, it provides security by using cryptography, which prevents altering the data to the maximum level possible. Therefore, it is considered as having a significant potential to ease and secure public and private business transactions and reduce costs.
In terms of legal processes, the technical concepts and terms of blockchain must be well understood since blockchain constitutes the origin and platform of smart contracts. Simply, blockchain can be defined as a distributed ledger, including a chain of transactions that is continuously adding another block of transactions and is recorded on multiple networks and computers [2]. Blockchain has two main concerns: admissibility and the “code is law” principle. The first is generated by the lack of necessary regulation and jurisprudence in different jurisdictions. As smart contracts do not have a unified definition or are considered legally binding in all jurisdictions, their admissibility is still being questioned. The second gives the impression of eliminating, in a way, the rule of law and introducing a technological alternative. The “Code is law” principle uses technology to enforce rules, which creates an automated world, dictated by codes.
The use of technology from the beginning of contractual relation
The first step of entering the technology bubble was determining digital content as the subject of a contract, which happened a long time ago. It is frequently used for searching for a potential counterparty, buyer, or user of an asset/service, like in the case of Uber.
At this point, the main issue is the legal characteristics of smart contracts. Can a smart contract be considered an agreement within the frame of the Law of Obligations or should it be considered a tool to enter an agreement or its execution?
Nick Szabo, a computer scientist and a cryptographer, introduced the “smart contract” concept. Accordingly, smart contracts enable parties to draw up the contact in code language. In other words, smart contracts are digital codes that provide an automated or self-executing program. In terms of smart contracts, we can list the below characteristics:
- Secured transactions – There are keys available either publicly or privately that identifies each user.
- Unchangeable nature – Once registered, the contract cannot be changed by anybody unless a deactivating feature is included in the algorithm.
- Self-execution – When conditions are met nothing can prevent the execution. This automation reduces cost. Although execution is guaranteed, the authority of the courts cannot be eliminated.
- Transparency – Even if the parties and the details of the contract cannot be accessed by others, everyone on the blockchain can know the existence of data.
Apart from the above, smart contracts have many aspects that vary from traditional contracts including costs, parties, intermediaries, and even negotiation.
Easy and frequent use of smart contracts in digital fundraising is undeniable, however, not everything can be subject to smart contacts, the subject must be assets that are registerable and controllable by the blockchain. In other words, smart contracts are limited to the digital world and their subjects can only be electronic transactions and digital assets [3]. On the other hand, smart contracts cannot be concluded where discretion comes into play. Many authors suggest that the code of smart contracts can’t interpret abstract terms of the law that we come across in traditional contracts such as “negligence”, “good faith”, “good cause”, “bona fide” and so on.
There are different approaches to smart contracts in different jurisdictions. The Swiss Federal Council defines smart contracts as a computer protocol allowing an automated execution between parties with previously coded data based on a decentralized system [4]. Accordingly, they have three main characteristics, no human intervention, immutability, and limitation to the digital world. Similarly, in US law, a smart contract is defined as a computer code, stored in a blockchain-based platform, that automatically executes all or parts of an agreement. [5]
Having said that, there is no solid definition of smart contracts in general, and the relation between digital codes and contracts remains unknown. It is still a question whether we can consider a valid exchange of consent as defined in the Turkish Code of Obligations No. 6098 Art. 1. Since the accepted definition also includes the completion of predefined steps that do not constitute any legal consequence, it is hard to place all smart contracts under contract law.
Therefore, the doctrine divides smart contracts into two: “smart legal contract” and “smart contract code”. However, there is a link between smart legal contracts and smart contract codes, as smart legal contracts require smart contract codes to be implemented. [6]
Electronic contracts are frequently confused with smart contracts. However, electronic contracts are different since their main requirements, and legal characteristics are almost identical to traditional contracts. Most importantly, they are equally admissible. In other words, they are contracts signed via electronic communication tools. Smart contracts, on the other hand, have a different nature and their admissibility is still being questioned.
In conclusion, although the smart contract is accepted as a new and different type of contract in the doctrine, it cannot be deemed as an alternative to traditional contracts within the current legislation. They are tools enabling the establishment or execution of online agreements, but certain conditions must be met to be legally binding. Nevertheless, disputes arising out of smart contracts will be governed by existing general principles of law, especially contracts law. In other words, despite the “code is law” principle, the rule of law cannot be put aside and the legal relations arising out of smart contracts will be governed by both general and private provisions of the law of obligations.
Authors:
Av. Özlem Bulut Penezoğlu
Founding Partner
Av. Mine Çınar
Associate
[1] Steven Norton – “CIO Explainer: What is Blockchain?” – Wall Street Journal, February 2016
[2] Dr. Pınar Çağlayan Aksoy – Akıllı Sözleşmelerin Kuruluşu ve Geçerlilik Şartları – 2021
[3] Dr. Pınar Çağlayan Aksoy – Akıllı Sözleşmelerin Kuruluşu ve Geçerlilik Şartları – 2021
[4] Federal Council of Switzerland – “Legal Framework for Distributed Ledger Technology and Blockchain in Switzerland”, December 2018
[5] Alex Lipton, Stuart Levi, Skadden – “An Introduction to Smart Contracts and Their Potential and Inherent Limitations” – May 2018
[6] ISDA and Linklaters – “Smart Contracts and Distributed Ledger – A legal Perspective”, August 2017