Navigating smart contract and cryptocurrency disputes – the key considerations from a litigator’s perspective
Parties can still find themselves in disagreement with one another and disputes frequently arise in the crypto arena.
The benefits of cryptocurrency and smart contracts can be significant and enjoyed by consumers and businesses alike across the world.
The network within which digital currency is held is secured by encryption techniques known as cryptography, which means data is stored and transmitted securely. It verifies and authorises transactions and the source of those transactions. The recording and validation of certain actions can be combined into one activity, and one consolidated, shared and agreed ledger exists. All permitted users collectively have control of that database and its data cannot be reversed/amended, meaning any transactions are permanently recorded. It follows that in certain circumstances there can be little dispute as to a payment being made or the actual terms purportedly binding the parties.
Similar to any legal relationship, parties can still find themselves in disagreement with one another and disputes frequently arise in the crypto arena. As with a traditional contract dispute, the substantive issues can be numerous, for example there may be arguments as to how, when and if the contract was formed and, if it was, whether the parties have performed their obligations in accordance with that contract. There may be a difference between the parties as to the interpretation of the terms of the contract, or perhaps that there has been some form of misrepresentation by one party in that regard.
In such circumstances, there are significant nuances to ‘crypto’ disputes to which parties must have regard. Here are the key considerations when crypto disputes arise:
Formation of contract
For a legally valid contract to arise between parties, certain formalities must be met. A smart contract is in many ways similar to a ‘traditional’ contract, in that the parties agree to provide something, for example services, in exchange for money or some other consideration.
The key difference is that they are executed digitally and automatically upon certain conditions being met. An example might be in a property purchase or rental, where upon the parties meeting all of the necessary criteria, a sale can complete or a ‘smart lock’ can be released to a tenant upon a rental payment being made.
The automation and self-execution of smart contracts gives rise to immediate uncertainties as to whether the party accepting the contract intended to do so or did so with their knowledge. In such circumstances, arguments might arise as to whether what constitutes an acceptance of the offer made by another party, and in turn as to whether the formalities of a valid contract have been met.
As a result of the blockchain having no physical location, jurisdictional issues and uncertainty as to the applicable law can arise.
A cryptocurrency is a digital currency held across a number of connected computers which form a network. The data is stored by a database known as blockchain, which effectively operates as a record keeper/ledger for transactions. Identical copies of the ledger are downloaded and stored on computers across the world. Blockchain therefore facilitates contracts between parties globally and transactions often take place via a consensus reached within the network, spanning multiple jurisdictions and countries.
The network is ‘decentralised’, which means that technology allows people to deal in the currency directly, rather than dealing through a centralised exchange or authority. As a result, the network is typically outside of the control of governments or central authorities, such as a bank or credit card company, and are therefore not subject to their rules.
With traditional international contracts, laws and their interpretation vary significantly between jurisdictions. This applies equally to smart contracts. In resolving a dispute or determining a claim, and in the absence of any ‘rules’ governing the contract, it is fundamental for the relevant countries to work together. This naturally has its challenges given the differing approaches between countries in recognising cryptocurrency and smart contracts, which are still in their relative infancy.
Due to the anonymous nature of blockchain/cryptocurrency, it can be difficult to identify precisely who the parties to the contract are, or who is in fact liable. Typically, users will use a ‘wallet’ to manage their cryptocurrencies which correlate to anonymous details, rather than names and identities.
At first blush, it seems unreasonable that those who invent the code upon which the smart contract can run should face any liability. However, if those developers could reasonably foresee the relevant events occurring, for example illegality or breach of contract, it might be that good arguments arise in respect of establishing their liability. Whilst it seems unlikely that the general network users are at risk of liability, the same might not be said of those processing the transaction, or the authors of the smart contract itself, in circumstances where issues could be reasonably foreseen.
Liability may ultimately depend on the precise issues in play, and the issue may not relate strictly to the substantive performance of the contract. Rather, the contract may have been impacted in some way by (for example) a defective system or coding error.
Smart contracts can be executed without a physical meeting and, as such, the potential for a fraud or misrepresentation is high. This is compounded by the pseudonymity of cryptocurrency and smart contracts generally. It is well documented that cryptocurrency and smart contracts have the potential, and are, exploited for illegal means, which might extend to parties fraudulently or negligently being enticed into a contract by misrepresentation.
As referred to above, blockchain is decentralised and can facilitate contracts between parties across the world. There are rules for how each transaction takes place and for how each participant should accept or reject those transactions. Consensus is often achieved when over 50% of the computers agree that a transaction is verified/authenticated. That transaction is then added as a ‘block’, chronologically, to the blockchain.
Whilst there are instances, therefore, where a consensus may be reached as to how to resolve a dispute, where the blockchain is ‘permission-less’ and is operating in a public sphere, resolving disputes comes with significant hurdles.
With a traditional contract, the determination of a dispute will be dictated by the relevant country and its courts.
Users can take some comfort from the fact that it is likely that cryptocurrency is recognised as property, and can be frozen, charged and enforced accordingly. See the UK Jurisdiction Taskforce legal statement in that regard.
However, jurisdiction is not a given and practical difficulties follow in terms of the steps that can be taken to preserve cryptocurrency. Significant investigations will be required to obtain information in respect of an opponent. Certain details may be obtainable, for example a user’s wallet key, and there may be some circumstances where third parties retain an element of control over a user’s currency. Notwithstanding that, ultimately the pseudonymity attached to cryptocurrency and smart contracts makes it difficult to enforce contract terms, or awards, in a traditional sense.
Alternative dispute resolution
The UK Jurisdiction Taskforce, chaired by Sir Geoffrey Vos (Master of the Rolls), has published the Digital Dispute Resolution Rules.
These rules promote and facilitate the speedy and cost-effective resolution of tech disputes. In particular, they enable the parties to elect for resolution by expert determination or specialist arbitration, with an outcome to be determined within 30 days. The parties can remain anonymous and can be awarded both traditional remedies and remedies tailored to digital assets, which can then be enforced in over 165 countries.
Smart contracts and cryptocurrencies are still relatively novel and navigating the inherent challenges of associated disputes can be difficult. Potential parties to a dispute can, however, take some solace in the fact that with the appropriate legal strategy and advice, and expert input, there are good options available to parties to enable them to cost effectively achieve their objectives.
Contact our commercial litigation solicitors for help and support on resolving a commercial dispute.