How is the UK handling Cryptocurrency and the Law? Part 2: Smart Contracts

Kirsty Goodary
July 2020


Welcome to Part Two of our series at Extropy.io.

We hope you enjoyed Part One, where we discussed the legal status of cryptoassets from the UK Jurisdiction Taskforce’s (UKJT) paper, “Legal Statement on Cryptoassets and Smart Contracts”. There’s also a link to the full paper at the end of this article.

This time, we’ll be discussing the UKJT’s findings for Smart Contracts, as well as what this means, in principle, for those who are part of smart contract agreements.

What is a smart contract?

A smart contract is a self-executing contract where the agreement terms are written in code.

It’s designed to reduce the need for human intervention. Instead, the smart contract can define the rules and it automatically enforces the terms of the contract.

Smart contracts are becoming increasingly popular due to their benefits. Some of these include preventing someone from avoiding their obligations, transparent terms, security and efficiency.

They have been adopted across multiple sectors so far, such for as insurance policy agreements, managing loan agreements and legal contracts.

In traditional contracts, a signature may be required. However, in smart contracts a person’s private key is used to authenticate their agreement to the contract.

The role of smart contracts can vary depending on the software;

  1. A person’s obligations can be defined by the code;
  2. Two or more people may enter into a contract and the code just implements the agreement, rather than defines it; or
  3. Two or more people may enter into a contract, partly with their obligations defined by code, partly with the code implementing the agreement.

But what happens when things don’t go to plan? Will smart contracts be legally enforceable? What if there is a system failure or the code doesn’t execute the way it was intended to. Can the parties settle disputes through legal intervention?

In order to answer these questions, Extropy.io will be looking at its unique features in comparison to traditional contracts.

What makes it so unique?

Like cryptoassets, smart contracts have some unique features;

  1. Automaticity;
  2. The terms of the contract can be written in code; and
  3. The performance of the contract can be enforced with similar techniques to cryptoassets (cryptographic authentication, distributed ledgers, decentralisation and consensus)

Due to these features, smart contracts are raising new legal issues compared to their traditional counterparts.

Requirements for a legally valid contract

Here’s a summary of the requirements:

  1. An agreement has been reached for the terms;
  2. The parties intended to be legally bound;
  3. There is “consideration”, meaning that each party will give something of benefit, like payment in return for goods or services; and
  4. There are no vitiating factors that would make the contract void, such as duress, misrepresentation or illegality.

Do smart contracts fulfil the requirements?

Agreement

Suppose Alice wants to enter into a contract with Bob. Alice gives Bob the contract and Bob chooses to accept these terms.

In a smart contract, typically Alice would offer the terms within the smart contract and it is then left open for Bob to accept. Most smart contracts are designed this way and they are similar to unilateral contracts.

When Bob wants to enter into the contract, his private key is used to authenticate his agreement to the terms.

Intention

What if Alice or Bob didn’t intend to enter into the smart contract?
Presume Alice wrote a smart contract for testing purposes only. Bob came across her contract and decided to accept these terms, not knowing that the smart contract was for testing. It’s likely that the contract would be void because Alice had no intention of entering into a contract.

If, on the other hand, Alice deployed her code on a public platform and advertised its presence to the world, it would be far more difficult for her to prove that she had no intention of entering into a contract.

Intention therefore really depends on the facts. If Alice wanted to void the contract on the basis that she didn’t intend to enter into one, it would depend on her actions prior to the contract agreement. The same applies for Bob.

Consideration

If there isn’t an issue with intention, there wouldn’t normally be an issue with consideration either. The performance of the smart contract, like payment in return for services, would be automatically executed.

What about Decentralised Autonomous Organisations (DAOs)?

The UKJT touched lightly on DAO’s and found that DAOs are similar to unincorporated associations, in that the members of a DAO are bound by the rules.

A DAO’s smart contract should have no trouble in being legally enforceable, provided that the requirements for a valid contract are met.


Conclusion

The UKJT found that despite its distinctive features, smart contracts can, in principle, be treated similarly to conventional contracts.

The benefits of a smart contract is their reduced need for legal intervention. They can reduce the risks of non-performance by a party, factual disputes, or disputes about the interpretation of the terms.

However, if the performance of the contract is hindered in some way, or a party didn’t intend to enter into the agreement, it’s possible that legal intervention will be available to determine the facts and resolve disputes.

Therefore, although smart contracts have brought about new legal issues, they are likely to be treated similarly to traditional contracts.

We are pleased that parties in smart contracts are likely to have access to recourse, which is certainly a positive step forwards.

It is impressive that not only are the UK able to handle future legal issues surrounding smart contracts, but they may also well equipped to handle any future issues surrounding Decentralised Autonomous Agreements (DAOs) as well.


In Part 3 we will be looking at a case where the Court used the UKJT’s Legal Statement as guidance, to determine whether cryptoassets do indeed have a property status. (Hint: we think this may be a watershed moment).

Extropy.io are a consultancy for blockchain and cryptography based in Oxford, UK. We help businesses and startups realise the full potential of the blockchain and bring them cutting edge technology in a way that non-rocket scientists can understand.

We also teach blockchain and cryptography workshops and give talks at conferences worldwide.

If you would like to find out more, please get in touch.

References : Legal statement on cryptoassets and smart contracts - UK Jurisdiction Taskforce