Understanding the emergence of smart contract technology and its legality and feasibility from an Indian perspective.
Demonetization in India has placed Blockchain-based Smart Contracts in a visible space. Blockchain technology has enabled the smooth transition from traditional to smart contracts by making them simpler and less expensive. Smart contracts are a vital step forward in automating the terms of an agreement between two parties.
For smart contracts to completely penetrate the Indian business circuit, the following aspects need to be focused upon:
- The myth of smart contracts not being analogous to traditional contracts, needs to be addressed.
- The legal clarification on status of Digital Currency is vital. Adequate regulation in the sphere of digital currency and smart contracts, will help in integration of digital contracts into present industrial standards. But, this transition needs the regulatory and logistical help of the RBI and Government structures.
What are Smart Contracts?
Smart contracts are computer protocols that embed the terms and conditions of a contract. The human readable terms of a contract are fed into an executable computer code that can run on a network. Many contractual clauses are made partially or fully self-executing, self-enforcing, or both.
Understanding Smart Contracts and Blockchain Technology
- Smart contracts are self-performing and operate in combination with blockchain. This enables them to move information of value on the blockchain between parties.
- Blockchain forms the backbone of all digital contracts and currency like the Bitcoin. It creates a transaction database that is shared by all nodes participating in a system based on the Bitcoin protocol.
Smart Contracts vs. Traditional Contracts
Contracts can be understood as agreements which are legally enforceable. The rights and obligations created by this agreement are recognised by law.
The idea of smart contracts is compatible with our understanding of traditional contract principles. Since, smart contracts also have legal backing, they fulfil the requirements of traditional contract law.
An important distinction between traditional and smart contracts is the medium on which the contract is formed. Commerce depends on individuals being able to form stable, predictable agreements with one another. Communication and physical ratification are the primary ways of creating a legal relationship. This infuses confidence of enforceability into the parties. The legal legitimacy and confidence of enforceability make traditional contracts a preferred way of forming contractual relations.
In smart contracts, the terms and conditions of contractual agreement are entered into the software code. But, this does not take away from the original character of the agreement. As long as the agreement creates a set of rights and duties or obligation, it is a valid contract.
Smart contract comprises of a new set of tools to articulate terms. The process of formation and articulation of contract is now embedded in a self-enforcing automated contract. Hence blockchain technology-based-smart contracts are a way to complement or replace, existing legal contracts.
For a wide range of potential applications, blockchain-based-smart contracts offer many benefits:
- Speed — Smart contracts use software code. These codes automate tasks that are typically accomplished manually. Hence, they can increase the speed of a wide variety of business processes.
- Accuracy — The probability of manual error is reduced due to automated transactions.
- Lower cost — Smart Contracts need less human intervention, fewer intermediaries and thus reduce costs.
- Auto-enforcement — Smart contracts are unique in their enforceability since these clauses are embedded in the applicable software itself.
Despite these benefits, there is hesitancy to participate in transactions involving smart contracts. This is because the status of digital currency is still ambiguous in India. Unlike traditional contracts, the legal position on enforcement, jurisdiction etc. is unsettled.
Yet, it can be seen that smart contract based transactions are much more popular in international parlance. Recognition for such transactions in major international commercial law statute have a profound impact.
Current Legal Scenario in India
Opponents of smart contracts in India argue that cryptocurrencies do not have the legal status as a currency in India. Hence, there is ambiguity about whether they constitute a ‘valid consideration’ as per traditional contractual principles.
- Cryptocurrency is undefined under the FEMA, RBI Act or Coinage Act.
- It is uncertain as to how Cryptocurrencies will be taxed and whether such tax will be a central or state subject.
- Recently, a multi-stakeholder panel comprising of members from the RBI and the IDRBT looked into the implications of blockchain technology.
- Since all transactions take place over the internet, the dispute resolution or clause reposing jurisdiction to courts or excluding jurisdiction of courts needs to be clearly spelt out. “Smart contract itself should envisage a dispute resolution mechanism involving external arbitrators and/or courts, where the contract is frozen pending proceedings, and the award of the court is incorporated into the terms of the smart contract. With regards to evidence, a dual-integration mechanism comprising hybrid ‘code + paper’ contracts can be presented in court.”
Commercial agreements comprise of clauses that protect parties from various liabilities. They are not always suitable for representation and execution through code. Hence it can be concluded that smart legal contracts will need a blend of code and natural language.
Smart contracts in the commercial realm are at a nascent stage. Hence, regulation in this regard will render adequate clarity to the functioning of smart contracts. This would ensure a smooth transition from traditional contracts to smart contracts in the near future.
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