Smart contracts and blockchain: Would be a positive regulation desirable?

The developments in the technology make now available new means of contracting and/or performing an agreement, where the human interaction is fully marginal or totally absent. This innovative way – already operating in some areas of Bitcoin, financial instruments, fintech, corporate governance, internet of thing – offers considerable advantages compared to a traditional fashion to perform a transaction. In this connection, these types of agreements – so-called “smart contract” – are carried out automatically (and basically instantly) through a computer running code, cannot be tampered with or stopped once entered into and are able to grant ex ante performances without state or judicial power intervention^[1]. The most famous species are the so called blockchains, originally designed in the Bitcoin protocol and now widespread in many other areas, with potentially limitless applications. These are decentralized ledgers, able to communicate without a central authority controlling them or previous mutual knowledge of the other databases involved in the chain. This technology is able to establishing consensus over parties in order to perform a certain transaction: each transaction is chronologically recorded by a network of computers in a database (the blockchain precisely): each blockchain, in turn, is encrypted and organized into smaller datasets such as “the blocks”; every block records the info regarding a number of transactions and it is able to communicate and recognize the preceding block belonging to the same chain through complex algorithms. When a new block is authorized to be added to the blockchain, it can no longer be deleted and the info it contains are permanently recorded and verifiable by everyone on the network[2]. In this regard, therefore, smart contracts raise questions about the role of the law and state authority as the need of a positive regulation of these transactions; in other words, given that this new way of contracting is self-executing and tamper-proof, is it really necessary or at least desirable to shape it in a legal standardized regime? This paper will address this key issue, providing a quick overview on the most common recurring uses of blockchains technology.

As mentioned above, the blockchain technology was originally designed in 2009 for the creation of the digital currency known as Bitcoin. This successful experiment enables to transfer funds around all the world in near real-time, with basically no transaction costs and state or public authority intervention. This revolutionary technology, not surprisingly, attracted a great deal of interest from financial institutions and now smart contracts are commonly used to perform derivatives, futures, swaps and options. Furthermore, there are growing number of projects which are developing new code programmes that ensure, for instance, the payment of salaries to the employees and the government fees to the state agencies in real time or the music royalties to copyright holders. In addition, the tamper proof feature makes blockchains technology particularly suitable for granting effective voting systems, to be employed in political election, proxy fights or other corporate decisions. However, these are only just some of the real applications where blockchains might transform our idea of execute an agreement. The more the technology will develop new sophisticated means to translate contractual terms into code programming language the more the limitations tied to ambiguity and flexibility of legal rules will be eliminated[3]. In this likely scenario, therefore, we will have perfect self-executing contracts able to transfer money, properties, goods, copyrights, count votes, send encrypted communications with zero transaction and litigation costs, without the need for state intervention. This is an important step in terms of ease of contracting and certainty in the execution of the agreements. In this connection, undoubtedly this is an attractive prospect, given that the main problems regarding transactions arise when there is a breach of the contract or when a judicial intervention is need to enforce the right of the fulfilling party. Nevertheless, this alleged flawless situation may rise several political and social implications: on one hand, regarding governmental powers and prerogatives and, on the other hand, about the remedies law should provide the individuals, consumer and end users dealing with smart contracts.

 From the former standpoint, indeed, the decentralized autonomous system of blockchain might completely bypass central governments, banks, courts, state governing laws and policies. Blockchain system, therefore, might undermine any state efforts to police and prevent the flow of illegal funds, banned products or illegal transactions, given the cross-border scope of smart contracts[4]. In other words, this new technology is able to “eliminate the possibility for legitimate forms of surveillance used for prosecution and law enforcement”[5]. In this respect, authoritative scholars, in analogy with what happened in medieval age with the Lex Mercatoria, are trying to give an answer to the question of a possible regulation, shaping the definition of Lex Informatica as a “set of rules spontaneously and independently elaborated by an international community of Internet users”[6].  However, this form of self-regulation has not its origin from domestic laws or legislator’s will, but rather from the software developers. For these reasons Lex Informatica cannot address properly the political and security concerns above raised with regard to illegal traffic of money, goods or data. In this connection, the concrete measures adopted by the state in term of regulation led to the “threat of law enforcement (coercive force), the manipulation of markets (financial incentives and disincentives), the development of new social norms (social pressure), or by exerting pressure on centralized intermediaries”[7], such as Internet service providers, search engine or social networks. However, the level of knowledge reached by our rule of law, in my opinion, allows managing blockchain technology in a way to avoid dangerous risks for international and domestic interests without resorting to harsher measures or legislation curbing freedoms of citizens.  Therefore, a room for the regulation and control in smart contracts and blockchains is necessary to avoid that their strengths became a weakness for the implementation of core state policies, private and crime laws.

On the other hand, as the remedies that law should adopt in order to grant safeguards to consumers dealing with self-executing smart contracts, I tend to prefer a liberal one as suggested by scholar Richard A. Epstein when is said that “what the law should do is to supply a second legal remedy that offers the complete relief (or at least more complete relief) that the self-help remedy could not supply”[8]. At present, legal doctrine, political institutions and court seem not to be able to fully understand the real implications of smart contracts. For these reasons, some law practitioners are tempted to dismiss the traditional ways to qualify a legal binding agreement, embracing the new concept of “smart alternative contracts”, namely novel forms of agreements commercially useful[9]. This empirical approach has the clear advantage to address the issue under a perspective which is half legal and half software driven, while waiting for business world and national legislators will develop effective ways to full exploit the benefits of this new way to perform transactions and will grant an adequate level of protection to end users.

In conclusion, smart contracts present a countless number of benefits in term of clarity, speed to agreements, individual freedom and user autonomy, reducing the marginal cost of transactions, enforcement, litigation and the risk of undue tempering. Nevertheless, these technologies have the potential to became a dangerous tool to circumvent domestic and international prohibitions or might leave the consumers without an effective protection when a breach of contracts arise. For these reasons, in my opinion, a form of “smart” regulation – but not draconian measures – should be adopted in order to grant: i) the state to police that the use of this technologies don’t harm national security and financial stability; ii) the citizens and end users fundamental rights and effective remedies in case of incorrect execution of the contract.