Smart Contracts & AI
By Chitra Jha, 4thYear, B.A. LL.B. National Law University Odisha
Artificial Intelligence: The definition of Artificial Intelligence (hereinafter referred to as ‘AI’) has two main dimensions: behavior and reasoning as both of them forms human’s thought process. Hence, the theory and development of computer systems that are able to perform tasks normally requiring human intelligence, such as visual perception, speech recognition, decision-making, and translation between languages is referred as AI.
Block-chain Technology: The Blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value. A network of so-called computing “nodes” make up the Blockchain. One of the best things about the Blockchain is that, because it is a decentralized system that exists between all permitted parties, there’s no need to pay intermediaries (Middle men) and it saves you time and conflict. Blockchains have their problems, but they are rated, undeniably, faster, cheaper, and more secure than traditional systems, which is why banks and governments are turning to them.
Smart Contract: Smart contracts are computer protocols that embed the terms and conditions of a contract. The human readable terms of a contract are fed into an executable computer code that can run on a network. Many contractual clauses are made partially or fully self-executing, self-enforcing, or both. A smart contract essentially works as a computer program that both expresses the contents of a contractual agreement and operates the implementation of that content, on the basis of triggers provided by the users or extracted from the environment. Smart contract code is different from smart legal contract.
Cryptocurrency: A cryptocurrency is a digital or virtual currency that uses cryptography for security. A defining feature of a cryptocurrency, and arguably its most endearing allure, is its organic nature; it is not issued by any central authority, rendering it theoretically immune to government interference or manipulation.
The dream of smart contracts traces as far back as 1994 wherein the contracts will be legally enforceable agreements that aren’t left to the mercy of legal interpretation and lawyers. However, it is only with advent of Ethereum, a new cryptocurrency and platform, that this dream now seems attainable. The digital currency comes with a new type of blockchain – a peer-to-peer database that provides a public and trusted record of transactions – that seems destined to kick-start the smart contract revolution.
HOW DOES A SMART CONTRACT WORK:
Smart contracts represent a next step in the progression of blockchains from a financial transaction protocol to an all-purpose utility. They are pieces of software, not contracts in the legal sense, that extend blockchains’ utility from simply keeping a record of financial transaction entries to automatically implementing terms of multiparty agreements. Smart contracts are executed by a computer network that uses consensus protocols to agree upon the sequence of actions resulting from the contract’s code.9 The result is a method by which parties can agree upon terms and trust that they will be executed automatically, with reduced risk of error or manipulation.
Technology leaders envision many applications for blockchain-based smart contracts, from validating loan eligibility to executing transfer pricing agreements between subsidiaries. Before Blockchain, smart contracts of such nature were not possible because parties to an agreement of this sort would maintain separate databases. With a shared database running a blockchain protocol, the smart contracts auto-execute, and all parties validate the outcome instantaneously and without need for a third-party intermediary.
Smart contracts are a worthwhile option where frequent transactions occur among a network of parties, and manual or duplicative tasks are performed by counterparties for each transaction. The blockchain acts as a shared database to provide a secure, single source of truth, and smart contracts automate approvals, calculations, and other transacting activities that are prone to lag and error.
SMART CONTRACT V. TRADITIONAL CONTRACT:
Contracts are agreements which are legally enforceable. The rights and obligations created by this agreement are recognized by law. The idea of smart contracts is compatible with the understanding of traditional contract principles. The essential concept of contract involves offer, acceptance, and consideration.
Traditional contracting generally involves one or more companies, several rounds of negotiations, back and forth drafting phases, and then the often lengthy administration of the finalized agreement.
Smart contracts are computer programs, also called blockchain contracts or digital contracts, create and enforce an agreed upon performance between two parties, much like the traditional counterpart. The difference, of course, is that smart contracts are computer-generated and thus it is the code itself that explains the obligations of the parties. In many cases, the parties to a smart contract are essentially strangers on the internet bound by this digitally-produced but binding agreement. The goal is obviously to facilitate business arrangements without the formality and cost associated with the traditional route.
MYTH AND REALITIES:
Myth 1: Smart contract cannot be legally enforced-
It is often argued that the traditional elements of contracts in India viz. offer, acceptance and intention cannot be gauged in a smart contract since negotiations happen electronically, with no clarity as to these components. Further, the difference between invitation to offer and offer also gets blurred causing confusion as to intention, and there exists no Privity of Contract.
However, contract-creation through electronic negotiation has been addressed in several international instruments. The European Draft Common Frame of Reference and Article 2.1.1 of the UNIDROIT Principles of International Commercial Contracts cover contracts involving automated performance arrangements, where parties agree on self-executing electronic platforms without the involvement of a natural person to ensure performance. ICC e-Terms are used to clarify offer, acceptance and intention of the parties to enter into automatically-concluded contracts. The fact that these provisions exist in international instruments reflects global support for digitally concluded and enforced contracts which ensure greater compliance than traditionally executed contracts.
In India, most of the opposition for smart contracts emanates from the fact that the cryptocurrency employed, more specifically Ethereum, has not been recognised as currency in India, stands legally unregulated and hence does not form valid consideration. It has not been defined under the FEMA, RBI Act or Coinage Act and it is believed that by virtue of the Latin maxim expressumfacitcessaretacitum, Ethereum is excluded from the definition of currency. Hence, current legal standing is that smart contracts are not legally binding as such in India.
However, it is a possibility that these currency could be legalized in India, as it has been in other Jurisdictions like Australia, EU and Japan because India has already adopted other forms of smart contracts before.
Myth 2: Smart contracts will make replace the need of lawyers:
Ideally it is assumed that since the human aspect will be done away with in smart contracts, the efficiency will be increased and reliability on the lawyers as intermediary as well will be reduced. However, the reality is that smart contracts can replace some contracts such as rental agreement etc. but it cannot replace all the contracts, and hence by logical extension replace lawyers.
Myth 3:Dispute resolution is problematic, as the jurisdiction of courts can be excluded-
It is believed that smart contracts administered with block-chain technology make it impossible to identify the seat of the contract i.e. the place where the contract was concluded and by implication, the proper law of contract, and the courts which have jurisdiction over disputes. This is seen as a dangerous means of opting out of any legal system, which could lead to the development of a potentially unregulated system of contracting.
But this is far from the truth. As Aeron Buchanan, former researcher at Ethereum.org, points out, the Ethereum system powering smart contracts itself envisages a dispute resolution mechanism involving external arbitrators and/or courts, where the contract is frozen pending proceedings, and the award of the court is incorporated into the terms of the smart contract. With regards to evidence, a dual-integration mechanism comprising hybrid ‘code+paper’ contracts can be presented in court.
Further, several smart contracts involve damage computation by third-party experts, which is the basis of recognized forms of ADR like arbitration.
BENEFITS OF SMART CONTRACTS:
• Speedy updates: Smart contracts use software codes to automate tasks that are generally accomplished through manual means, they can increase the speed of a wide variety of business process.
• Accuracy: There exists more accuracy in case of automated transactions as compared to manual transactions.
• Lower execution risk: The decentralized process of execution eliminates the risk of manipulation, nonperformance, or errors, since execution is managed automatically by the network rather than an individual party.
• Fewer intermediaries: Smart contracts can reduce or eliminate reliance on third-party intermediaries that provide “trust” services such as escrow between counterparties.
• Lower cost: New processes enabled by smart contracts require less human intervention and fewer intermediaries and will therefore reduce costs.
RISKS & DISADVANTAGES OF SMART CONTRACTS:
Smart Contracts will function on the technology of Blockchain which is based on decentralized network. This form of technology being in its nascent stage has its own loopholes and disadvantages. The decentralized system cannot be trusted and has privacy issues as the code within smart contracts is visible to all parties within the network, which may not be acceptable for some applications. Moreover, there is issue of anonymity wherein it becomes difficult to access the fraudulent behaviour. There exists possibility of misuse. Smart contracts’ underlying technology presents enforceability issues. Smart contracts have many business benefits, but there are clearly still legal hurdles to overcome.
Future of smart contracts: Ethereum is a public Blockchain platform and the most advanced for coding and processing smart contracts. The concept is still undergoing research but future for the same seems bright if proper regulations are put in place. However, the myth regarding smart contracts replacing lawyers is very vague and cannot be justified, neither in India nor in other jurisdictions.
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