With the advent of modern technology and innovation, we are moving towards a more digitised world where automation is the name of the game. The ideas surrounding the blockchain, artificial intelligence and big data are revolutionary and are poised to change the way business and human infrastructure operates. Today, these the concepts are closer to us than one might first think, and stand to indelibly change our lives.
This brings us to a concept of smart contracts. Put simply, a smart contract is a self-executing contract that is triggered upon the happening of certain pre-determined events. The concept of a smart contract may be traced back to a paper authored by American computer scientist Nick Szabo in 1996, titled “Smart Contracts: Building Blocks for Digital Markets.“1 In the paper, Szabo explores the idea of embedding certain kinds of contractual clauses in the hardware and software of a computer program, which are structured in a way that breach of contract would be, possibly even prohibitively, expensive for the breaching party.2 He explains this concept through the analogy of a vending machine, wherein smart contracts go through the machine in order to dispense the desired product: to operate a vending machine you would need to input a command (offer), you would need a certain amount of money (consideration), and then the machine will dispense the product (acceptance).3 Fundamentally, if you use the same inputs to operate the machine, the same outputs shall be reached each time. Intrinsically, vending machines are automated machines, and as such, smart contracts are the automation of its software.
Today’s smart contracts are programs that operate and are stored on a blockchain, that are self-executing and run when the encapsulated code, which contains certain predetermined conditions for the execution of the agreement, are met. This process is typically done by following simple “if/when…then…” commands. Following Szabo’s vending machine analogy, if/when someone inserts money and enters a certain command on the machine, then the product corresponding with the command so entered will be automatically dispensed by the machine, successfully executing the contract. Modern day smart contracts operate on the blockchain, which is a public electronic ledger that creates an immutable record of transactions by way of a distributed and decentralised network of computers. Each transaction recorded on this network is entered into an encoded ‘block’, which is a set of information. Each block can store a certain amount of data per block, and once a block is filled it will be closed and all following data will be stored in a succeeding block. Each new block is connected to a previously filled block, forming a chain of blocks, or a blockchain. The entirety of this data stored creates the electronic ledger that we now know to be the blockchain, an immutable and transparent public record of information, which may be accessed at any time. Given that contemporary smart contracts operate on a blockchain, they imbibe some of the properties of a blockchain, including immutability, meaning they cannot be modified once they have been created.
Crucially, the two primary benefits of the self-executing and incontrovertible nature of smart contracts are ‘trustlessness’ and efficiency, with the latter being a consequence of the former. The execution of traditional contracts hinges on the performance of the terms of the agreement by the parties, while an automated smart contract shall not be executed unless the prearranged terms of the line of code that forms the contract have been met, dispensing with questions of enforcement of the terms; if the predetermined conditions of the code have not been met, the contract shall not be executed. Thus, with smart contracts, the question of non-performance doesn’t arise, and the threat of executional disagreement doesn’t exist. However, smart contracts may not be a panacea for ensuring compliance with the terms of an agreement, and come with its own set of problems. For example, several issues may arise due to the inherently inalterable nature of smart contracts that prevent parties from changing the terms of that agreement once it has been entered into a block, leaving no room for negotiation of terms after the creation of the contract. Additionally, issues as to jurisdiction may also arise. Given that blockchains are globally accessible ledgers, a transaction may very well span multiple geographies and jurisdictions, all with their own interpretation of contract law, and perhaps even their own laws relating to smart contracts and blockchains. As such, issues of applicable law and appropriate jurisdiction could likely lead to complications.
In the Indian context, we have had a chequered past with blockchain application, starting with the 2018 ban on using virtual currencies,4 to the quashing of this notification by the Honourable Supreme Court,5 to talks of a Central Bank Digital Currency. Under the existing legal framework for contracts, a valid contract must satisfy the fundamental criteria of contract formation, being: offer, acceptance and consideration. The Indian Contract Act, 1872 (“Contract Act“) necessitates the existence of a party’s indication of their willingness to do or not do something, for the purpose of gaining another party’s assent for that act or omission.6 For smart contracts, the language of the self-executing code shall indicate the existence of intention to contract with another party, and the act of publishing that line of code for a single smart contract on any blockchain, would amount to the communication of an offer. Next, the assent, of another party, to the terms outlined in an offer amounts to acceptance of that offer.7 For the execution of a smart contract, it is imperative that the other party/ies carry out certain tasks or functions that the contract necessitates. As such, any party who performs the requisite functions, as outlined by the code for the execution of the smart contract (be it by way of inputting certain commands in a vending machine), shall have accepted the offer. Finally, as per the Contract Act, consideration includes any act done for the benefit or interest of a party, or may be qualified by some detriment or loss suffered by the other party.8 In the context of a smart contract, given that only if/when the act outlined in the code is carried out, only then shall the contract be executed. Therefore, the performance of the conditions envisaged by the code of the smart contract shall amount to valid consideration. Further, the Contract Act states that, “all agreements are contracts if they are made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not hereby expressly declared to be void.”9 Given that smart contracts may only be executed when the predetermined conditions envisaged and encapsulated under the code are met, the parties seeking to enter into an agreement under that smart contract would thus have to have consented to the execution of the terms of the for the code (or smart contract) and thus would have agreed to enter into that contract.
Further, the Indian Evidence Act, 1872 (“Evidence Act“) recognises “information stored, recorded or copied in optical or magnetic media produced by a computer” to be a document admissible as evidence.10 While, under the Contract Act, a smart contract may be a valid contract, and the Information Technology Act, 2000 (“IT Act“) additionally recognises electronic contracts as valid,11 Indian law relating to electronic records and contracts may not apply to smart contracts. Per the Evidence Act, an electronic contract is only considered a valid agreement if it is authenticated by way of an electronic signature, as obtained in accordance with law.12 Further, these digital signatures are only legally recognised and enforceable under the IT Act,13 if they are created in accordance with the rules made by the Central Government.14 However, while each smart contract on any blockchain may be specifically identifiable to the contracting parties, these identifiers don’t employ digital signatures in the form that Indian law requires, and thus may not enjoy the status of electronic contracts under Indian law.
There is little doubt that the real world applications of this technology, such as in cases of maintenance of land records thereby avoiding title fraud, have the potential to automate and streamline processes and systems that are notoriously difficult to navigate, and perhaps even help lessen the burden of title disputes from our judicial system. However, smart contracts come with a plethora of regulatory and policy issues, including problems of jurisdiction and the potential of fraud arising out of the anonymity of the process of executing a smart contract. While the theoretical benefits of employing blockchain technology and automating contracting, at least in certain areas, can’t be denied, concerns with such application still exist, and, at the very least, the Indian regulatory framework would need to be amended and aligned to govern smart contracts.
1 Szabo, Nick, “Smart Contracts: Building Blocks for Digital Markets“. 1996. Available at https://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/
2 ibid at 1.
3 ibid at 1.
4 “Prohibition on Dealing in Virtual Currencies“. Reserve Bank of India. April 26, 2018. Available at https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11243.
5 Internet and Mobile Association of India v. Reserve Bank of India, W.P. (Civ.) 373/2018 (SC).
6 Section 2(a) of the Contract Act.
7 Section 2(b) of the Contract Act.
8 Section 2(d) of the Contract Act.
9 Section 10 of the Contract Act.
10 Section 65B(1) of the Evidence Act.
11 Section 10A of the IT Act.
12 Section 85B of the Evidence Act.
13 Section 5 of the IT Act.
14 Section 10 of the IT Act.