AN ANALYTICAL STUDY ON REGULATION OF SMART CONTRACTS IN AUSTRALIA

THIS ARTICLE WAS WRITTEN BY ANUPAM TEWATIA, A STUDENT OF MACQUARIE UNIVERSITY, SYDNEY

INTRODUCTION

With the advent of technology in the modern era, the concept of contract used in business, commerce and day to day lives changed from a paper-based contract to the online based smart contracts. The digital age saw the need of the hour to regulate contracts via computers to connect customers and traders residing in different geographical areas.

 The term ‘smart contract’ was initially proposed in the early 90s by Szabo for the application in the e-commerce sector, but the term has now more often been used for the distributed ledges technology and particularly in blockchain technologies. A smart contract is a computer program or a protocol with an intent to execute, control automatically the legal actions which are present in the terms of the agreement.[1] It is a self-enforcing and self-executing protocol which is governed by the terms and conditions of the contract.[2] The blockchain based contracts require the parties to first negotiate and agree on the terms of the agreement and then commemorate these terms in the smart code contract either entirely or partially.[3]

These automatic transactions have been possible due to the series of technological developments in the computer systems such as the Electronic Data Interchange^[4] that have enabled decentralisation and have replaced the intermediaries such as the lawyers, the banks and other offline registries, in transactions between two contracting parties.[5] Smarts contracts being digital and via computer system have their own advantages and application. Smart contracts are considered to be accurate and transparent as all the information and codified terms are fully visible to all the parties and this facility removes all the manipulation and biasness, in turn increasing the confidence in execution of the smart contract.[6]

Not only does smart contract provide transparency, but they also provide a sense of security. These contracts are tamper-resistant due to the decentralised data storage which underpins blockchain technology. The distributive nature of a blockchain makes it incredibly hard to tamper the information, once it has been recorded in the blockchain. Therefore, a party does not have the ability to modify it or stop the execution of a smart contract unless provided in the code itself. [7]

LEGAL CHALLENGES

Even though smart contracts have certain advantages, they are still lagging in the legal and function front. One of the major drawback of a smart contract is its formation. These contracts are in form of codes and the users have to code their own contracts and deploy them in different blockchain which is very difficult for a person with no or very less technical knowledge. Once these codes are deployed, it is nearly impossible to change or modify them, which poses another big problem. Another challenge is the unique programming language used in these smart contracts which makes them non readable to a layman.[8]

In a legal sense, a smart contract must meet all the requirements of a binding contract. Any undue influence would make the smart contract void at law, even though they are unstoppable in the digital sense. The identity of the party coming into the contract, or the capacity of the person is usually unknown which makes it difficult to trace back. [9]

Some to the major legal challenges that the smart contracts incur have been discussed as follows:

1. Capacity

Contractual capacity refers to the individual’s ability to enter into a contract. Under Australian law, minor under the age of 18 is considered to be incapable of coming into a contract as he or she lacks capacity unless they are contracting for a necessary item or service.

When the parties enter into a smart contract, it is often a very high risk that the one parties have not attained the prescribed age of contract and is a minor who is hiding under the cloak of technology and internet. This not only make the contract void, but also poses a difficulty in its enforcement. Moreover, in the commonwealth countries the enforceability would depend on whether such contracts would come under the umbrella of necessaries. However, it is dubious to suggest that buy cryptocurrency is a necessary for a minor.[10]

2. Jurisdiction

Another interesting challenge that the smart contracts face is the decision of which jurisdiction would the smart contract fall under if there is a breach or error in the coding. As the blockchain operates on the decentralised ledger, it is possible to form a smart contract from anywhere across the globe making it difficult to locate the parties of the contract. They do not reside in one location and are located in different places at the same time, yet our laws are based on the jurisdictional approach. [11]

This jurisdictional approach can be highly problematic as different jurisdictions have different rights, laws and regulation that govern these smart contracts, resulting in confusion when there is a contract violation.

3. Formation via technology- Offer and Acceptance?

Under the Australian law, an offer is indicated by a party’s intention and willingness to bound by the promise that was made to the other party with an option to the other party to accept or reject the given proposal. In traditional contracting, it is fairly straightforward to identify where there has been an offer and acceptance, while considering the circumstances and the conduct of the parties.

The only exception the prevails in this regard is the postal acceptance rule which provide that the acceptance occurs as soon as the post has been sent. However, this does not apply to instantaneous forms of communication in both Australia and England. England though regulation 11 of the EC Directive Regulation 2002, provides that communication ‘will be deemed to be received when the parties to whom they are addressed are able to access them’.[12]

Now, assuming if two parties were negotiating regarding the sale of goods to form a smart contract, the formation of the contract would initiate by messages sent using public-key infrastructure (PKI) in the similar manner to that of the emails. It would be necessary to establish whether the offer has been validly made and accepted. The question now arises whether the acceptance occurred once the party seeking to purchase the goods sends their offer, or once it is authenticated through consensus of network users or once it is coded and enters the blockchain.[13]

AUSTRALIAN LAW ON SMART CONTRACTS

The problems concerning smarts contracts remains the same in Australia as well. Australian laws and regulations are considered to be insufficient in governing the smart contracts, even though the Australian government is pushing hard to bridge the gap between the technology and legal framework. It is believed that smart contract codes are not smart enough to eliminate these challenges of misrepresentation, jurisdiction, enforcement and security on its own. As the smart contracts are based on the blockchain technology, Australia has made certain laws to protect the customers while performing these smart contracts.

There are limited regulatory measures around blockchain technology in Australia. The present challenge is to provide a clearer legal policies and ethical framework for the use of blockchains. Additionally, there is a lack of clear rules for the compliance of regulations like the know-your-customer (KYC), anti-money laundering (AML) and counter- terrorism financing (CTF) and plus which ‘code’ can be considered as legal agreement still remain an issue. [14]

Australia needs a regulatory environment that encourages innovation and development that can only be accomplished by ensuring that Australian regulatory processes are founded on standards and are technology-neutral, and the regulators understand the value of encouraging innovation and investment, while when interpreting and implementing regulations.

Because of the decentralised nature of blockchain technology and cross-border operations, any court order for injunctive relief would have to deal with readjusting the post-execution status of the parties following the contract, which will necessitate identifying the parties to which any changes must be made, which, as previously mentioned, can be extremely difficult. [15]

Until now, regulators’ primary concern with blockchain implementations has been the risk of consumer damage from speculative goods, unregulated exchanges, and outright scams involving blockchain-based digital currencies including Bitcoin (referred as cryptocurrencies). In 2017, for example, the ACCC received over 1,200 complaints regarding cryptocurrency-related scams.[16] After April 2018, the Australian Competition and Consumer Commission (ACCC) has assigned authority to the Australian Securities and Investments Commission (ASIC) to take action relating to crypto assets under the Australian Consumer Rule. Even if the ICO does not include a financial product, this delegation allows ASIC to take action against misleading or deceptive actions in the promotion or sale of ICOs.[17]

At the moment, there is no specific regulation that deals with blockchain technology or other distributed ledger technology (DLT) in Australia. However, the ASIC provided with an information sheet that outlined the basic regulatory issue that may arise when implementing the blockchain technology, which can further regulate smart contracts. [18]

Numerous cryptocurrency (a type of a smart contract) networks have also implemented the smart contract technology or the self-executing contracts. These are permitted in the Electronic Transaction Act 1999 (cth) (ETA) which provides the legal framework for the electronic contracts and commerce to operate in the same way as that of the paper-based contracts. The ETA looks into the smart contract but the does not provide for the legal challenges that they face. ETA provides that the self-executing contracts in Australia are acceptable if they fulfil the requirements of a basic contract. As the cryptocurrency network has also adopted the blockchain technology, it is feasible that smart contract regulations can be co related to the cryptocurrency laws. [19]

Several Australian laws apply to the regulation of cryptocurrencies and other blockchain-based properties, including the Corporations Act 2001 (Cth) (financial goods and services regulation). The Australian Securities and Investments Commission Act 2001 (Cth) (establishes the Commission’s role and powers in relation to consumer protection in financial services) Australian Consumer Law, which is contained in the Competition and Consumer Act 2010 (Cth) (regulation of non-financial products and services); Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) (anti-money laundering obligations and registration of digital currency exchanges); and Income Tax Assessment Act 1997 (Cth).

However, the aim of many of the blockchain use cases being developed is to improve consumer security. The diamond company De Beers recently announced that it had conducted a trial using blockchain to allow for safe traceability of individual diamonds from their mining source, as an example of how blockchain applications are already being used in this context. Another example is a pilot programme developed by an Australian vitamin manufacturer (Blackmores) and a New Zealand dairy producer in collaboration with Australia Post, New Zealand Post, and Alibaba, China’s largest e-commerce firm, to enhance supply chain integrity and prevent the selling of fake food goods to customers.[20]

Another issue that the Australian legislation has not looked into is the error detection in the electronic contracts. Article 15D (2)c of the Electronic Transaction Act 1999 provides that ‘the person, or the party on whose behalf the person was acting, notifies the other party of the error as soon as possible after having learned of the error and indicates that he or she made an error in the electronic communication;’[21] It provides that a party has to notify the other part on error detection, however these transactions are in coded form which are very difficult to understand for a person with no technical knowledge. So, if the person is not able to understand then how does the law expect them to find the error and notify the other party?

CONCLUSION

Smart contracts and blockchain technology need certain reforms and clearer legislation for the betterment of the customer and the traders. Although there have been some steps taken to regulate these smart contracts, however it still needs a huge push forward in the legal front. To get the smart contracts in the running wheel, it is best if the gap between the lawyers and technology is reduced so that both can work hand in hand to make the smart contracts “smart”. The government must take necessary step to bring the smart contract to the same level to that of the ordinary paper-based contracts.

[1] Nick Addison et al, ‘Blockchain Challenges for Australia’ ACS (Web Page, May 2019) https://www.acs.org.au/insightsandpublications/reports-publications/blockchain-whitepaper.html.

[2]  Matthew McMillan et al, ‘Australia: Smart(er) contracts in 2020’, Mondaq (Web Page, 09 August 2020) https://www.mondaq.com/australia/new-technology/974460/smarter-contracts-in-2020.

[3] Ibid.

[4] Guido Governatori1 et al, ‘On legal contracts, imperative and declarative smart contracts, and blockchain systems’ (2018) 26 Artif Intell Law 377.

[5] Salmerón-Manzano et al, ‘The Role of Smart Contracts in Sustainability: Worldwide Research Trends’ (2019) 11(11) Basel.

[6] Matthew McMillan et al (n 2).

[7] Matthew McMillan et al (n 2).

[8] Zibin Zhenga et al, ‘An overview on smart contracts: Challenges, advances and platforms’ (2020) 105 Future Generation Computer Systems 475.

[9] Michael Bacina , ‘Smart contracts in Australia: Just how clever are they?’ (2017) 39(10) Bulletin (Law Society of South Australia) 22.

[10] Mark Giancaspro, ‘Is a ‘smart contract’ really a smart idea? Insights from a legal perspective’ (2017) 33(6) Computer Law & Security Review 825.

[11] Matthew McMillan et al (n 2).

[12] Mark Giancaspro, ‘Is a ‘smart contract’ really a smart idea? Insights from a legal perspective’ (2017) 33(6) Computer Law & Security Review 825.

[13] Mark Giancaspro (n 12).

[14] Nick Addison et al (n 1).

[15] Mark Giancaspro (n 12).

[16] Michael Milnes, ‘Blockchain: issues in Australian competition and consumer law’ (2019) Australian Journal     of Competition and Consumer Law.

[17] Ibid.

[18] ‘Blockchain and Cryptocurrency regulation 2021 | Australia’, Global Legal Insights (Web Page) https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations/australia.

[19] Ibid.

[20] ‘Blockchain and Cryptocurrency regulation 2021 | Australia’, Global Legal Insights (Web Page) https://www.globallegalinsights.com/practice-areas/blockchain-laws-and-regulations/australia.

[21] Electronic Transaction Act 1999 (Cth) art 15D 2(c).