Smart Contracts – What Does the Law Say?

There is much talk of smart contracts in the National Bank of Denmark paper on payments.

Whether in the context of CBDCs or other payments, they are frequently put forward as an attractive ‘prize’ worth pursuing.

Smart contracts are made possible in a digital payment context because software can automatically make payments when specific conditions are met. The payments are in line with formal agreements. They are already being used in the world of cryptocurrency exchanges, online gambling etc. The advantage of a smart contract is that it is fully automated requiring no paperwork to be processed.

Smart contracts can be written in ‘natural language’, which is then performed by code or entirely in software code. If the latter and something goes wrong, rectification is more problematic than for code written based on natural language.

In all probability, if a payment is made which one party regards as being made incorrectly, it is likely to end up in court. Unfortunately, laws have almost all been written based on an analogue view of the world, making a digital reality hard to interpret. A case in the Singapore courts considered a case involving algorithmic trading, Quoine v B2B2, where human involvement was reduced. To quote from the article, ‘the Court’s view was that the relevant individual whose knowledge was to be assessed is the programmer, and the court must consider whether such a programmer had actual or constructive knowledge.’

Even if a court decides that an error has been made, an immutable smart contract cannot be amended or ‘rectified’. New code is probably necessary. But if a ledger is immutable, how do you reverse a transaction? If other subsequent transactions rely on the original transaction being in the ledger, how can a correction be made? If the smart contract is being used for cross-border transactions, then the agreement needs to be clear on where digital transactions take place and where the ledger is located. When has ownership been clarified?