Solving blockchain smart contract disputes

Originally published at Machine Lawyering with Aaron M Lane and Marta Poblet.

Blockchain-enabled smart contracts can change how we exchange value over the internet. We now have the technology to code agreements into blockchain protocols, enabling those agreements to self-execute when particular conditions are met. This execution happens without relying on centralized intermediaries—such as banks or governments—but rather through decentralized blockchain networks.

Today, entrepreneurs are experimenting with smart contracts on blockchains, aiming to disrupt an enormous array of industries including property registries, prediction markets, voting and supply chains. These frontier contracting technologies are now widely considered to shift the way that we arrange our economic, social and political activities.

Smart contracts are “agreements—or parts of agreements—that are coded to operate within a decentralized or distributed blockchain network, and that can be automatically executed by that network when specific conditions are validated.” The core innovation here is to move reliance away from centralized parties to execute contracts. Instead, contractual performance relies on computer code verified by a decentralized network rather than the good graces of the counterparty with the cooperation of other intermediaries. This gives parties greater confidence that the contract will be carried out according to the agreement.

Parties using smart contracts will face similar problems as traditional contracts. Contracts are incomplete not just because we lack the cognitive capacity to write entirely contingent contracts, or because of the cost involved in negotiating those various contingencies, but also because the future states of the world are fundamentally shifting and uncertain. Dispute resolution will be required to deal with this uncertainty.

But for smart contracts to compete with traditional contracts as a way to govern our exchanges, there are other shortcomings too. Things can go wrong when smart contracts execute. As examples, these problems might be because of an erroneous or compromised oracle, or the underlying logic could be exploited by a malicious party. Surmounting the problem of what happens when things go wrong is essential in driving adoption—and further innovation—of smart contracts in the burgeoning cryptoeconomy.

When things go wrong, how are disputes resolved? Dispute resolution for smart contracts is more difficult than what it first looks like—there might be pseudonymous parties, in different jurisdictions, with unclear avenues for government recognition (or even outright hostility). Should smart contracting parties look to the courts in national jurisdictions (squeezing problems back within centralized institutions), or do we need native digital dispute resolution services?

Our recent article, “The Governance of Blockchain Dispute Resolution,” published in the Harvard Negotiation Law Review, looks directly at this problem of governing smart contract disputes.

Smart Contracting Disputes are a Governance Choice

The choices that contracting parties make when resolving their smart contract disputes are, ultimately, governance choices within different institutional alternatives.

In our paper, we frame this governance choice within new comparative economics, or the way that we compare different institutional governance structures (e.g. private orderings, courts, regulation) to solve economic problems.

When smart contracting parties are thinking about how to govern disputes they might consider how different paths ameliorate two different costs. First, there are “disorder costs”, where other private parties take advantage of the dispute resolution process (e.g. the risk that another private person or company might cheat, delay or otherwise subvert the process). And, second, there are “dictatorship costs”, or the costs that governments will expropriate value using their monopoly powers. No governance solution to the dispute resolution problem solves these problems perfectly (they trade-off between these costs in different ways) but these costs help us to understand and compare different governance choices for smart contracting parties.

The dispute resolution choices open to smart contracting parties include:

  • Non-binding negotiation and/or mediation. Due to the non-binding nature of these arrangements this choice comes with substantial disorder costs because contracting parties could hold-up the dispute resolution. Few dictatorship costs exist as there is little role for governments.

  • Binding private arbitration. The outcomes from private arbitration could feed directly back into a smart contract (via an oracle) to enforce the dispute resolution outcome. While this might come with lower risks of disorder costs, there is an increased risk of disorder from the centralized powers of an arbitrator.

  • Courts. Parties could seek to have their contracts recognized and dealt with through territorial courts. Governments could then use their traditional means (e.g. orders for compensatory damages or specific performance) in an attempt to resolve disputes. This choice, however, has higher dictatorship costs, as judges and other judicial officers exercise coercive powers of the state.

  • Regulatory state. Another possibility is that the government could require smart contracts to include code that mandates a particular form of dispute resolution. This choice is characterised by lower disorder costs (because there is little opportunity for parties to subvert the process) but higher dictatorship costs (because a “one-size-fits-all” approach ignores individual differences and prevents innovation).

Blockchain-enabled Dispute Resolution

The scope of potential dispute resolution alternatives is not predetermined. Entrepreneurs are using blockchains themselves to develop next-generation decentralized dispute resolution. In this way, blockchain-based smart contracts not only create dispute resolution problems, but they can act as infrastructure to solve those problems, propelling further innovation in online dispute resolution mechanisms. Interpreted within the framework above, these services better seek to overcome the costs of dictatorship and disorder in governing dispute resolution. Ultimately these are forms of protective-tier entrepreneurial discovery of the cryptoeconomy.

There are a range of platforms that offer more decentralized dispute resolution services, providing new legal infrastructure for the cryptoeconomy. The table below offers some non-comprehensive examples in this space:

Smart contracts have propelled further innovation in online dispute resolution mechanisms. There is a fruitful and expansive research program into blockchain-based dispute resolution. Understanding the institutional evolution in this space is critical not just for the future of the blockchain-based cryptoeconomy and its legal systems, but also as these new frontier dispute resolution platforms begin to service more traditional contracts.

Note: This post draws on our article published in the Harvard Negotiation Law Review, ‘The Governance of Blockchain Dispute Resolution’.

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