By Wulf A. Kaal & Craig Calcaterra
The rapid evolution of anonymous, autonomous, and distributed blockchain-based smart contracting creates friction and enforceability issues with existing legal and jurisdictional principles, calling the future governance of blockchain technology into question. The effective governance of blockchain technology and smart contracting is essential to ensuring its continuing evolution. Based on the mathematical principles underlying the disposition of blockchains, we propose and evaluate an alternative approach to the existing legal exercise of jurisdiction that is inherent in blockchain technology itself. We call this distributed jurisdiction.
This contribution is not merely theoretical. The Ties Network demonstrates that anonymity can be perpetuated in blockchain technology, despite blockchains’ eternal storage of information and its growing size working against anonymity. The Aragon Network highlights that the technology itself offers means of internal controls that help ensure effective governance in the continuing evolution of the technology.
Because of its very expansive and near universal applicability, it is crucial for the broadening evolution of blockchain technology to find jurisdictional means for the governance of the crypto economy that is facilitated and sustained by blockchain technology. A lack of governance and conflict resolution mechanisms would undermine the democratized trust created by blockchain technology and hinder its broadening evolution and applicability. Jurisdictional means are the basis for effective conflict resolution mechanisms applicable to crypto transactions in the blockchain. Not having the required jurisdictional means necessary for conflict resolution mechanisms for Ethereum blockchain-based smart contracting, may invoke consumer mistrust in the new technology. This can then undermine the evolution of the blockchain-based crypto economy.
Regulatory alternatives for blockchain-based conflict resolution are necessitated by the impossibility of consistently identifying the parties in any dispute in the context of crypto transactions on the blockchain and the associated problems of applying the existing legal infrastructure. We cannot conceptualize opportunities in the crypto transactional universe that could possibly enable and allow a court in the existing legal infrastructure to decide and enforce any disputes between crypto transactional parties. Because of the severity of these challenges for the existing legal and jurisdictional infrastructure, we conclude that the sensible approach for including good governance in crypto transactions necessitates instituting governance solutions inherent in the blockchain technology itself. Accordingly, we introduce the concept of a distributed jurisdiction, which we hereinafter evaluate.
Lack of Regulatory Recognition
The lack of regulatory recognition of blockchain technology creates uncertainty for the blockchain community. The lacking recognition hinders the implementation of the technology across industries and undermines infrastructure conversion via blockchain technology. The regulatory uncertainty derives from insufficient or non-existent regulatory guidance, sparse court decisions, uncertainty over jurisdiction, and a sense in the user community of interacting in an environment that is generally free of law. As the technology applications grow and the value of crypto currencies rises, the evolution of blockchain-based crypto economy will depend to some extent on users’ trust in the efficacy of blockchain-based dispute resolution mechanisms and the immutability of the technology.
Courts have not yet recognized blockchain technology or addressed legal implications of blockchain-based applications. For the most part, the technology industry agrees that blockchain technology is immutable and secure. However, a review of published court opinions suggests that no court has had to review, assess, or scrutinize the uses and applications of blockchain technology at the time of publication of this article, which creates uncertainty in how courts may perceive and treat blockchain technology.
Some may argue the technology is no different from other virtual technology that courts have evaluated. However, we claim that blockchain technology provides a challenge that is qualitatively different from any other technology that has been brought to traditional courts in the past.
Blockchain ledgers do not exist in a physical sense, and therefore have no specific location. The blockchain is distributed, meaning the nodes in any public blockchain network can be located all over the world. Arguably blockchain transactions can therefore be subject to the legislation of any given node in the network. However, the nodes themselves are autonomously run, extremely redundant, and may be anonymized with encrypting protocols.
Therefore, the infrastructure does not fall under any traditional jurisdiction, but the users of the infrastructure also naturally evade any sense of traditional jurisdiction. All parties may transact entirely anonymously on a public blockchain.
Anonymity of Blockchain Transactions
The lack of identifiable parties in crypto transactions creates a distinct separation between real world and crypto transactions that has lasting implications for the application of existing jurisdictional principles. Every user on a public blockchain is anonymized by the use of public-key encrypted identities. The tandem use of virtual private networks (VPNs) can then prevent the identification of the parties to a smart contract.
Without identifiable parties, jurisdictional principles such as subject matter jurisdiction, personal jurisdiction, diversity jurisdiction, and federal question jurisdiction become irrelevant. To illustrate this point, proving personal jurisdiction by means of 1. Physical Presence, 2. Domicile/Place of Business, 3. Consent, and 4. Minimum Contacts becomes impossible as none of these elements are known of the parties in a smart contract. Physical presence is anonymous, as is domicile, consent, and minimum contacts. Subject-matter jurisdiction, e.g. a given court can exercise power over a claim that the laws of the jurisdiction authorize such court to hear, is inapplicable because no given law would be able to authorize such power. But even if a given State or even the Federal Government were to pass a law that would grant such authority to a court, it is hard to see how the court would in fact exercise such authority, short of limiting access to the internet itself.
Not all smart contracts are fully anonymous and untouchable by traditional jurisdictional means. Some smart contracts will not automatically anonymize the parties because there is a physical element to such a consumer contract. For example, a powerful traditional corporation may wish to execute a complicated, non-hostile takeover of another company. The transparent, public, and perfectly logical structure of a smart contract could theoretically improve communication in such a negotiation. Other smart service contracts can be completely anonymous. For instance, a service contract involving services pertaining to cyberspace, such as programming services to create a given webpage, will be completely anonymous. It is important to note that as the technology becomes more widely accepted, such service contracts are going to become a highly important part of any given economy.
Even outside of cyberspace services, it is clearly possible that bounties for anonymous work executed via smart contracts will make traditional service contracts that require personal knowledge and physical appearance unnecessary. A bounty contract for anonymous work allows an anonymous person to put a bounty on a given job and offer such job on an anonymous smart contracting network to an anonymous counterparty. The contract acceptance and performance is dictated to some extent by reputational factors that link the counterparty and the performance under the contract.
Enforcement of Smart Contracts
The enforcement of smart contracts with traditional legal means is limited. First, disputing a smart contract with traditional means (in court, arbitration, mediation, etc.) is only marginally possible because of the aforementioned anonymity in blockchain transactions. Moreover, while smart contracts are coded as self-executing contracts, they do not necessarily provide effective mechanisms for enforcement if one party breaches his or her obligations in the smart contract. Semantically it could be argued that breach of a smart contract is not technically possible: the contract is entirely coded with mathematical logic and simply will not execute if a parameter is not fulfilled.
The literature is split on remedies for breaches of smart contracts. Some argue that because the smart contract replaces the existing legal contract in some circumstances, the smart contract will be governed by the same legal principles as the existing legal contract. Others argue that the breaching party may not live in an area where the courts have jurisdiction, thus the breaching party cannot be liable. In that case, assuming the operator knows identities of contracting parties, the operator of the blockchain platform should have a legal obligation to identify who the breaching party was and serve as the counterparty in a dispute scenario. These experts argue the operator of the blockchain should establish governing rules of the blockchain and specifications for dispute resolution. However, these specifications would have to be disclosed upfront and agreed upon by the parties to the smart contract in order to be enforceable.
Courts may be substantially challenged in interpreting smart contracts. Unlike the interpretation of a contractual dispute in the existing legal infrastructure where courts will assess what the contentious language in a given contract may mean to a reasonable human observer, smart contracts are not coded for a human observer. Rather they are intended for computer programming in a network of nodes (and in the future for artificial intelligence). To the extent that consumers are using smart contracts, the human element may be increased via the coding of graphical user interfaces. The basic premise of smart contracting remains emphasized on computer programming (and in the future artificial intelligence) not human interaction. Because of the emphasis on code for computer programming (and artificial intelligence), courts may not be able to hypothesize a reasonable human’s interpretation of a given smart contract. Courts may also be limited in their ability to consult programmers to interpret the coded language at issue in a given case because the meaning and logical reasoning of coded language is substantially different from human language.
From an evidentiary perspective, it is unclear who would own smart contracting blockchain contributions and whether there would be any applicable protections, such as work product or confidentiality. Without ownership rights for a blockchain transaction, it is also unclear who would be able to claim privileged information or how discovery would operate via existing laws. However, when the parties to a smart contract choose to reveal their identities, arguably privileged information or discovery laws should apply as if it was a written contract despite the fact that the contract was written in code.
Contract law remedies may not apply to smart contracts which raises possible enforceability issues. If a transaction in a smart contract fails to be completed or is partially completed but not added to the blockchain, it is unclear how liability will be allocated if those eventualities have not been accounted for in applicable code. Because of the blockchain’s decentralized nature, it is unclear who or what is accountable and could require regulation. Without solutions for those issues, liability for failed transactions or conflicts between parties have little guidance as to being resolved.
The nature of smart contracting necessitates crypto dispute resolution mechanisms. Problems with smart contracts tend to be two-fold. First, while smart contracts can be coded for and encapsulate a substantial portion of possible breaches of contract, subjectivity in human relationship, bounded rationality of coders and contracting parties, incomplete foresight, incomplete information, and opportunistic behavior will make breaches or other problems in smart contracts inevitable. Second, the first DAO has demonstrated that software and coding bugs will be inevitable in the evolution of the crypto economy. As the existing jurisdictional infrastructure is bound to produce suboptimal results for such crypto disputes, intra-blockchain distributed jurisdictional means are needed.
Our proposal for a distributed jurisdiction over blockchains has to fulfill two core requirements: 1. The anonymity of blockchain-based smart contracting has to be maintained as the technology evolves. Without anonymity of blockchain-based smart contracting the existing jurisdictional means (in personam jurisdiction) can apply to smart contracting which would undermine the evolution of the crypto economy and make distributed jurisdictional means unnecessary. 2. Distributed jurisdictional means necessitate governance from within the blockchain technology itself to effectively address the problems inherent in blockchain-based smart contracts. Without internal blockchain-based governance, a fully self-sufficient crypto economy may not be possible as legacy systems and governance intermediaries in the existing legal infrastructure will attempt to interfere with crypto transactions, resulting in suboptimal outcomes that cannot be fully resolved in the existing legal infrastructure.
Both requirements for the development of distributed jurisdictional means, full anonymity and intra-blockchain jurisdictional means, can already be accomplished. First, the Ties Network project demonstrates that anonymity can be perpetuated in blockchain technology, despite blockchains’ eternal storage of information and growing size working against anonymity. Second, the Aragon Network demonstrates that the technology itself offers means of internal controls that help ensure effective governance in the continuing evolution of the technology.
The current blockchain characteristics undermine the continuing anonymity of blockchain-based transactions. Anonymity removal in blockchain transactions is a serious problem that in fact undermines the evolution of the technology as it undermines trust in the technology-supported transactions. First, because the blockchain is immutable, blockchain-based transactions will be eternally stored and cannot be removed or deleted. Eternal storage itself works against anonymity. Second, as blockchain-based transactions increase in popularity, the size of the blockchain grows rapidly which will eventually require special equipment that can only be afforded by large corporations in the existing legal infrastructure. With such power for large corporations comes the possibility of dangerous centralization and a threat to undermining anonymity.
Automatic Blockchain Solutions
In a simple sense blockchain technology provides its own solutions for jurisdictional issues, governance, and conflict resolution. Blockchain technology resolves disputes of contracting parties by calculation. If a transaction is invalid it is checked automatically and quickly by any node and ignored. This is the inherent meaning of “self-executing, self-regulating”. If two competing/contradictory transactions are valid, then the system automatically resolves the primacy of one over the other according to computing power. Whichever transaction is embedded in the longer computation chain will have primacy. No decisions can be made once a transaction is added to the network. No governing body currently exists to petition for recourse.
Despite the dispute resolution mechanisms embedded in blockchain technology, smart contracting in a commercial setting will eventually require additional dispute resolution mechanisms. Problems with smart contracts are inevitable because of the subjectivity in human relationship, bounded rationality of coders and contracting parties, incomplete foresight, incomplete information, and opportunistic behavior. Such human limitations will eventually make breaches or other problems in smart contracts inevitable, despite coders’ attempts to optimize code in an effort to avoid such human traits in smart contracting. Add software and coding bugs to the human limitations and conflict resolution mechanisms become a necessity in the evolution of the crypto economy.
The Aragon Network already suggests dispute resolution solutions that can help the consumer acceptance of smart contracting and crypto transactions. Aragon will use a form of digital jurisdiction governed by a representational democracy of anonymous judges and regulators, whose power is based on their stakeholder share of the network and supplemented by a reputation system. Whenever a user wishes to dispute the execution of a contract in the Aragon Network, they post a bond (which will be returned if the dispute is decided in their favor) and a brief of their argument. 5 judges who have posted bonds will be randomly selected from all the users of the network. The judges read the litigants’ briefs and issue their judgements. Majority decisions determine the outcome of the dispute. If a judge ruled with the majority, they are rewarded monetarily; if not, they are punished with the loss of their bond. 2 appeals are possible. If either party disagrees with the judgment they may appeal by posting a larger bond with their argument. This opens a prediction market, where any user in the organization may become a judge by posting a bond. The arguments are read and all judges return their verdicts. Again majority determines the result of the dispute, with rewards or punishments for judges are given based on whether they sided with the successful party. The final appeal is made to a panel of 9 “supreme court” judges comprising the most successful judges in the network. A larger bond is posted by the appellant at each stage to prevent the wasting of system resources.
Ricardian Contracts – OpenBazaar
OpenBazaar is a distributed program that provides an online trading platform for any type of merchandise using cryptocurrencies. It does not use a blockchain for its core architecture, but it is a distributed network and all parties and transactions are anonymous. Because of these core elements in the OpenBazaar network we consider it appropriate to compare its dispute resolution mechanism.
The essential ideas of OpenBazaar’s system can be profitably employed on general distributed and anonymous business transaction platforms: 1. If both parties can agree on the type of transaction they are performing before signing a contract, a particular pool of arbiters can be chosen automatically. 2. A pseudonymous web of trust can be implemented to generate reputation for arbiters without compromising anonymity.
A core feature of the OpenBazaar dispute resolution mechanism involves so-called notaries. In the event of a dispute between parties, assuming alternative dispute resolution (ADR) had failed, the system includes a third party – the so-called notary. Users may choose not to involve the notary from the beginning of a transaction, in which case the smart contract has no transaction fees. However, the payment option without notaries involves risk because in that case, no arbitration is possible. The notary’s primary job is to electronically verify the contract has been signed by both parties and funds are available in escrow. Second, the notary verifies both parties are satisfied the terms have been fulfilled, then releases the bitcoin from escrow to the vendor. Finally, in case either party is not satisfied with the transaction, the notary acts as an arbiter in the dispute.
The allocation of notaries to contracts is an important mechanism for comparison of dispute resolution mechanisms. Similar to Aragon, notaries in the OpenBazaar system are generally randomly chosen and allocated to a given contract. However, in OpenBazaar the creators envision assorted pools of private notaries with varying expertise. Parties can theoretically agree which pool of notaries to choose before the contract is signed. This mechanism encourages the development of expertise within the system while satisfying the overarching goal of maintaining the anonymity of vendors and customers, since the details of a dispute are kept secret assuming the professionalism of the randomly chosen notaries.
The anonymity of the notaries is crucial to keep the system secure. Without anonymity, notaries could be coerced into revealing private information revealed in a given party’s case. Therefore, the notary pool is reviewed using a pseudonymous web of trust to determine reputation. Pseudonymity is achieved using public keys.
OpenBazaar provides many benefits to disputants that are not included in the Aragaon dispute resolution approach. Similar to Aragon’s system of appeals, OpenBazaar imagines an appeal system that includes randomly selecting new notaries from the agreed upon pools according to reputation. However, OpenBazaar’s more complex structure giving disputants the power of selecting between notary pools is a clear improvement over Aragon’s method of completely random selection from the entire group of users posting judge bonds. OpenBazaar’s approach naturally encourages notary pools to develop expertise in the various fields of law. Even though there is a chance that disputants’ private information may be revealed in the course of a dispute, the reputation of a notary depends on their professionalism in maintaining the privacy of their clients.
Aragon’s whitepaper is not specific about how much private information is broadcast to the blockchain, but it seems to suggest their judgements have minimal information. In fact, Aragon appears to not even post a summary of their arbiters’ reasoning which may cause the losing party to second guess the legitimacy of the entire dispute resolution mechanism in Aragon.
Limitations of Existing Solutions
Despite its much-needed introduction of dispute resolution and smart contract optimization improvements of the Ethereum network, the Aragon network still encounters several limitations. First, without full and continuing anonymity throughout the crypto evolution, the application and evolution of Aragon’s distributed dispute resolution mechanisms may not be viable in the long run as traditional jurisdictional means would attempt to take over without the assurance of full anonymity in blockchain transactions. Second, the random selection of judges from users of the Aragon network may only limitedly ensure the effective dispute resolution. Over time, users will inevitably demand the highest possible expertise of their judges and arbitrators. Without judge’s expertise in a given smart contract subject matter of a dispute user confidence in effective and fair conflict resolution is undermined which leads to overall less confidence in crypto transactions as a whole and can undermine the evolution of the crypto economy. Third, the democratic decision of a majority of judges giving binary decisions in the Aragon dispute resolution in combination with its judges’ lack of verifiable expertise may undermine user confidence in effective and fair dispute resolution. Fourth, users in the Aragon system would only informally be able to use lawyers or other consultants and perhaps would use lawyers from the existing jurisdictional infrastructure to help optimize their arguments in support of their claims. Support from lawyers trained in the existing jurisdictional infrastructure and without additional training in quantitative science and coding can lead to suboptimal results for transacting parties in smart contracts. Fifth, Aragon does not allow opting into different dispute resolution mechanisms. Only a user of Aragon can use their dispute resolution mechanisms. As other smart contracting platforms are being created, a need for more diverse, nuanced, and effective dispute resolution options emerges.
Several additional factors suggest that the dispute resolution scheme in Aragon could be improved. The random selection of user judges in the Aragon network introduces a level of arbitrariness to dispute resolution mechanisms that many private users but especially larger entities, including corporations in the existing legal infrastructure may not appreciate. Especially the submission of judges to the more popular vote and the economic incentives for judges to follow a more popular vote (in the Aragon system judges keep their bond if they voted with the majority), despite the overall anonymity of the voting, may call required notions of effective, non-arbitrary, and fair dispute resolution mechanisms into question. Users who are dissatisfied with such suboptimal conflict resolution mechanisms may wish to opt into a more nuanced conflict resolution network that helps them ascertain their rights and guarantees balanced outcomes.
Similarly, the OpenBazaar supported Ricardian Contract is subject to multiple shortcomings. Technically OpenBazaar does not use smart contracts. Instead “Ricardian” contracts are used, which have one extra layer of identification between the human-readable version and the code-readable version of the contract. The performance of the Ricardian contract is not always completely self-executing, and hence needs the third-party notary. The primary disadvantage of OpenBazaar’s system, compared with Ethereum’s smart contracts, is this extra layer of verification and the associated transaction fees. Because of these fees, the OpenBazaar dispute resolution mechanism creates substantial transaction costs that can be avoided by pure Ethereum-based self-executing smart contracts. Because every disputable Ricardian Contract has an arbiter/notary connected with them to automatically, check the contract, and hold funds in escrow until the contract is validated, such contracts follow the established legal order for contracting to a significant extent. Despite the clear gains they achieve with distributed, anonymous computing, still significant additional transaction costs remain because of the associated notary intermediator. Smart contracts make such transaction costs unnecessary but need a sound system for dispute resolution which we herein propose.
Proposal for a Distributed Jurisdiction
To address the above limitations, we recommend the creation of a distributed jurisdiction in the blockchain with the following tenets.
First, parties should agree on a pool of arbiters before the contract is signed. Random arbiters are elected from the chosen pool in the event of a dispute. This encourages specialization and the development of expertise within the community of anonymous arbiters.
Second, arbiters within the pool give written summaries of their judgments. Such explanations lessen claimants’ dissatisfaction in traditional courts, and opens the possibility for more nuanced resolutions.
Third, arbiters’ reputations are determined by a pseudonymous upvoting system of their judgment summaries. This may be protected from Sybil attacks by proof-of-timelock protocols and/or representative democracy based on reputation. This quickly improves the expertise of the pools while protecting anonymity, as judgments which reveal private information will be quickly discouraged with downvotes.
This article highlights the need for creating blockchain-based jurisdictional means as a basis for emerging conflict resolution mechanisms. Solutions for the incompatibility problem between blockchain technology and the existing legal jurisdictional infrastructure will evolve with the evolution of the technology itself.
While conceptually we believe in the incompatibility of the crypto evolution via blockchain technology with the existing regulatory infrastructure, it is important to appreciate the many gradations of blockchain technology and its broadening application bases. Given the gradations, it would be imprudent to claim perfect and universal solutions to the incompatibility problem we highlight in this article. Still there are some general principles that are applicable to broad situations.
We recommend the creation of a distributed jurisdiction in the blockchain which includes pools of randomly chosen arbiters based on reputation determined by an upvoting system.