Author Leonardo Molinaro – Senior Legal Specialist at OCTO
- Smart Contracts and Blockchain Technology
“Blockchain” technology, and its many areas of application, can be counted among the most interesting and topical issues in legal doctrine and jurisprudence.
This article will explore the use of blockchain in the formation of contracts, so-called “smart contacts,” its legal nature and the protection it can, or could, provide to consumers should be used to consolidate B2C relationships.
The Blockchain[1] guarantees, precisely, a verifiable blockchain that once registered in the system can no longer be modified, changed or tampered with.
In relation to the topic of this paper, is of fundamental importance the introduction of the concept of a “distributed ledger” which is a technology that can be linked to a ledger capable of being distributed in multiple copies to an indefinite number of people (read “consumers” in the present case), and capable of guaranteeing a high level of security, since, by not requiring human intervention, except to a very small extent and when extremely necessary, it significantly reduces the cyber risk to which such technology is exposed.
The aforementioned technologies are to be considered as technological tools capable of ensuring the traceability of all the steps leading to the consolidation of the contractual will of the parties, and thus to the contract itself, to make it irrevocable while also ensuring the certainty of the performance of contractual obligations.
Smart Contracts and “Distributed Ledger Technology” are mentioned in the Italian legal system, which introduces a definition of DLT and Smart Contracts in Law 12/2019 in conversion to D.L. 135/2018 and more specifically in art. 8-ter which states: ” 1. “Distributed ledger-based technologies” are defined as IT technologies and protocols that use a shared, distributed, replicable, simultaneously accessible, architecturally decentralized ledger on a cryptographic basis, such as to allow the recording, validation, updating and storage of data both in the clear and further protected by encryption verifiable by each participant, not alterable and not modifiable.
A “smart contract” is defined as a computer program that operates on distributed ledger-based technologies and whose execution automatically binds two or more parties on the basis of effects predefined by it. Smart contracts meet the requirement of written form upon computer identification of the parties involved through a process having the requirements set by the Agency for Digital Italy with guidelines to be adopted within ninety days from the date of entry into force of the law converting this decree.
3. The storage of a computer document through the use of distributed ledger-based technologies shall produce the legal effects of electronic time stamping referred to in Article 41 of Regulation (EU) No. 910/2014 of the European Parliament and of the Council of July 23, 2014.
Within ninety days from the date of entry into force of the law converting this decree, the Digital Italy Agency shall identify the technical standards that technologies based on distributed registers must possess in order to produce the effects referred to in paragraph 3. ) “[2]
Going into more detail about the subject of the analysis in this paper, it is possible to say that there is no single definition of “smart contract”[3] as this is a term that, first adopted in the 1990s, has been applied to increasingly advanced but at the same time diverse technologies.
According to the most recent majority legal doctrine, Smart Contracts are types of legal transactions consisting of a purely IT part, namely the “smart contract code” and a legal part referred to as the smart legal contract, the actual binding legal transaction between the contracting parties[4] .
The key feature of smart contracts is that the parties meet their respective contractual wills according to the logic of “if this… then that…,” i.e., that upon the occurrence of the precondition “this” must achieve, in order to fulfill the outstanding obligation under the smart contract, the result “that” through the execution of the contractual clauses under the smart contract without the help of a third party[5].
In order for a smart contract be considered as a contract within the meaning of the regulations dictated by the Civil Code, it must be composed of three fundamental elements, namely, the account (certain and immutable identification of the parties involved), the assets that are the subject of the transaction (the assets involved) and the contract itself.
With reference to the requirements of the contract set forth in Article 1325 of the Civil Code[6], it can be easily inferred that these are present in the smart contract, making it a contract for all purposes binding between the parties and deserving of protection.
In fact, it is possible to say that the meeting of the parties’ will is improved through the scheme provided by the Civil Code, i.e. proposal and acceptance, although this agreement is made instantaneously to then create the blockchain on which the Smart Contract will operate.
The assets mentioned above, just as with typical formations, are the object of the contract, and just as with traditional contracts, the non-existence of the asset will trigger the impossibility of execution of the smart contract according to the logic of “if this… then that…” and thus the consequent nullity of the contract itself.
We will not dwell on the requirement of the written form as it would merit an in-depth study by itself, this topic being the subject of a diatribe dating as far back as 1985, when UNCITRAL for the first time, on December 11th, adopted the first recommendation on the subject, but we will simply point out that the Italian (and European) legislature recognized the legal value of smart contracts with the Simplification Decree no. 135/2018, converted with amendments by Law No. 12 of February 11, 2019, expressly attributing to smart contracts the same evidentiary effectiveness as the written form as long as there has been computer identification of the parties involved.
In light of the above, it is possible to say that Smart Contracts, executed through DLT technology, are agreements between two or more parties, aimed at establishing a judgmental relationship between the contracting parties, having a specified, or specifiable, subject-matter, in written form and thus fully falling within the definition of contracts under Article 1321 Civil Code.
- Smart Contracts and Consumer Protection
Given what has been explored in the previous paragraph, it is possible to state with legal certainty that the discipline inherent in Smart Contracts can also find application in the area of consumer protection, and that indeed, it is precisely in this area of law that these instruments could take on a fundamental role in increasing the typical protection that the consumer deserves given what is provided for by Italian and European law of which the former is a derivation.
The greater protection that Smart Contracts guarantee to the consumer derives precisely from the automatism with which the contractual fulfillments of both parties are put in place, in fact it would be consumers, more than other stakeholders, who would benefit from automatic execution as it would provide an effective remedy to the difficulty of such parties to enforce their remedies judicially in the face of a default put in place by the counterparty, in addition to eliminating, with the traceability guaranteed by blockchain technology, any situations of information asymmetry as well as reducing risks of fraud and manipulation.
As a preamble to this analysis, it should be pointed out that although the technology adopted for such contracts provides for a pseudonymity system, it is easy to identify the contracting party, and thus possibly qualify him or her as a consumer since the identification of contracting parties is a requirement under Italian law principles to the very effectiveness of the contractual relationship based on blockchain technology.
With regard to the typical institutions adopted by the Italian legal system to protect the consumer in his capacity as a weak subject, it is possible to affirm that the adoption of Smart Contracts is well suited to comply with these forms of guarantees, as will be seen below.
First of all, it is worth repeating what has already been explicited in the previous section, in fact just as in B2B relationships and in B2C contracts, Smart Contracts allow both an acceptance by adhesion and a negotiation on the entire body of the contract and on specific clauses in full adherence with the provisions of Article 34 of the Consumer Code regarding unfair terms.
With reference to the information obligations to protect the recipients of consumer services, with particular reference to the requirements of Article 13 of Legislative Decree no. 70/2003[7], that is, the obligation of the proposer to provide for the delivery of the confirmation of the order received containing the summary of the general and particular conditions applicable to the relationship established and information regarding the main peculiarities of the object of the contract (including the price, means of payment, withdrawal modalities, delivery costs and tax discipline of the good) can only find a more facilitated application with the introduction of a contract that, operating on blockchain technology, guarantees the automatic, certain and transparent fulfillment of these information obligations.
The right of withdrawal is also easily guaranteed through the application of Smart Contracts, as in the process of creating such contracts there may be a period in which the consumer is free to withdraw from the relationship established at distance by putting in place the automatic execution of this right through the founding technology of Smart Contracts, as well as any other typical contractual fulfillment.
The European Commission, after the failure of CESL[8] , has focused its attention on consumer protection in the digital sphere, concluding that there is a need for digital technologies to be accessible to consumers and not to a restricted and qualified number of users such as those pertaining to the exchange of cryptocurrencies.
In this sense, therefore, the Smart Contract is legally placed, which, when executed on blockchain technology, is qualified as a natural digital evolution of the General Conditions of Contract to date shared with the consumer often in ways that do not facilitate their understanding, acceptance and possible enforcement if necessary.
Therefore, according to the development of doctrine, in line with what the European Commission has indicated, the adoption of Smart Contracts as the main model of administration of the General Terms and Conditions to the consumer would allow both a high degree of standardization of the text presented and the guarantee of compliance with the typical protections guaranteed by the European and national system to the consumer.
Concluding this brief discussion regarding the legal efficiency of Smart Contracts, and the applicability of this tool to B2C relationships, we find it superfluous to dwell on the legal validity of such tools, which is unquestionable in the opinion of the writer, but rather we would benefit from dwelling on the beneficial effects that this tool could have when applied to consumer contracting.
As mentioned on several occasions throughout this discussion, the Smart Contract is executed on the blockchain network, and this allows the enforcement of contractual obligations assumed by both parties through the automatism typical of such an instrument, and consequently the enforcement of the contract’s provisions by the consumer would see both time and cost of justice greatly reduced if not zeroed out (see, for example, the reimbursement for an air carrier’s delay of more than 3 hours that can be disbursed automatically by cross-referencing the aircraft’s departure and landing times), while, on the other hand, with traditional contracts, the consumer often finds himself having to give up the exercise of his rights due to the high cost of legal actions designed to ensure consumer protection.
Considering this, the introduction of such automatism could radically change the relationship, and approaches, by companies to consumers, as bound by the typical functionality of Smart Contracts operating on blockchain network, they are unlikely to engage in behaviors that qualify as unfair and/or aggressive business practices, protecting the effectiveness of consumer rights.
[1] Which is defined by Mauro Bellini in “What it is how it works and application areas in Italy” as “a technology that enables the creation and management of a large distributed database for managing transactions that can be shared among multiple nodes in a network.”
[2] For a digression on the relevant European and international legislation, see https://www.legaltech-smartcontract.it/quadro-normativo/.
[3] According to the ESIC (Higher School of Commercial Engineers) Spanish Institute, the notion of a “smart contract” was first defined by North American computer engineer, cryptographer and legal expert Nick Szabo in 1994 as “a computer protocol capable of enacting the terms of a contract.”
[4] Mateja DUROVIC, André JASSEN, The formation of blockchain-based smart contracts in the light of contract law, in European Review of Private Law, (6-2019), pp. 753-772, p. 756
[5] On the formation of smart contracts see “Next generation currency, “Home is smart contracts?”” which lists the six key steps of smart contract formation as follows:
- Two or more parties identify a common interest.
- They write a smart contract together by setting desired conditions and effects.
- They insert the smart contract into the chosen Blockchain.
- The Blockchain itself becomes ii guarantor of/ contract.
- When consent is obtained in the network, the contract “executes” its terms.
- After the conditions have been executed, the Blockchain will be updated by the state change de/system
[6] Article 1325 C.C.: “The requirements of the contract are:
- 1) the agreement of the parties [1326];
- 2) the case [1343];
- 3) the object [1346];
- 4) the form, when it appears that it is prescribed by law under penalty of nullity [1350, 1352].”
[7] https://www.normattiva.it/uri-res/N2Ls?urn:nir:stato:decreto.legislativo:2003-04-09;70
[8] Proposal for a Regulation of the European Parliament and the Council on a Common European Sales Law, COM/2011/0635.