Blockchain Technology: Importance of Transnational Laws and Jurisdictional Issues in Blockchain Dispute Resolution

By: Rabindra Kumar Mitra


INTRODUCTION

“The real problem is not whether machines think but whether men do.”

– F. Skinner

Today, the term ‘Government’ is associated with incompetence, corruption, red-tapism, and power being concentrated in the hands of the few. The same picture is reflected in Banks, Courts and other instruments of the State. So, what happens if these intermediaries are released from their supervisory roles and all their functions are handed over to technology? Here enters blockchain, a revolutionary technology that promises to shift the balance of power from centralised authorities in the field of communication, business, governance and even individual freedoms, to the ‘little man’.

However, when the state is removed from its role and there are no governments or Courts, what happens to due process and the fundamental right for a fair trial? The question being asked is if the entry of the next big thing in the ‘Internet of Things’ paves way for an ideal world run on ‘autopilot’ mode or will removing trusted third party intermediaries set the world back by 300 years. This paper tries to answer these questions through the lens of blockchain technology.

BLOCKCHAIN DISPUTES: THEIR NATURE AND FUTURE

Originally conceived as a technology underpinning the cryptocurrency Bitcoin, blockchain technology comprises a distributed database functioning as a ledger. It stores recordable information in ‘blocks’ and ‘chains’ them to form a cohesive record of information. Unlike traditional databases, in the blockchain, the ledger is recorded, maintained, and updated by consensus of all the participants in the network (called ‘nodes’); instead of one central computer. This decentralisation allows blockchain to boast of twin advantages of credibility and security.

Any attempted addition or change to the data in the blockchain has to be authenticated by all the nodes in the network, and any validated change to one ledger automatically updates all the others. Therefore, to hoodwink the blockchain system, a hacker has to tamper with not one, but all the blocks in the blockchain (since each block contains the ‘hash’ of its previous block, along with a time stamp and ‘proof of work’ unique to it) and repeat the exercise in all the nodes.

Armed with immutability, transparency, and security, Blockchain threatens to permeate through all industries and has diversified into creating self-executing digital contracts (smart contracts) and intelligent assets that can be controlled online (smart property). While some claim that its coded automaticity makes law obsolete, it raises a plethora of legal questions. Besides the problems such as terrorism financing, anti-money laundering and tax evasion, there are issues like the right to reverse an erroneous transfer, the ownership of stolen coins, or the effects of succession on virtual assets.

The most important type of dispute that blockchain can face is a contractual dispute. The most revolutionary feature of blockchain is its self-executing ‘smart contracts’. However, the legal status of the ledger in the blockchain, as well as, the DAO (Decentralised Autonomous Organisations) and smart contracts is unclear. They are also the potential source for lengthy blockchain litigations in the future.

Secondly, there is a danger of potential regulatory disputes. Regulatory and compliance issues are the biggest factors behind resisting the adoption of blockchain technology. The trans-border nature of blockchain and the ledger being maintained by nodes across the world will give rise to serious conflicts between nation states asserting jurisdiction over the blockchain-enabled platform.

Thirdly, a technological dispute in the form of failure of the code may result in unmitigated losses to the users of a system, where human intervention is either negligible or nil. Technical failures and loopholes in the software code are the main cause of the other dispute types and cannot be completely distinguished from them.

Finally, theft and other illicit activities are the most vital reason behind blockchain disputes. The promise of anonymity and apparent freedom from regulations is bound to lure many illegal activities to employ blockchain for financial transactions, like the recent case of the narcotics supply website Silk Road. Apart from this, the threat of cryptocurrency fraud, DAO fraud, stealing of private keys, data theft also looms large.

IMPORTANCE OF TRANSNATIONAL LAWS IN BLOCKCHAIN DISPUTE RESOLUTION

At the dawn of the internet, it was widely believed that the cyberspace was a terra nullis – an area beyond the scope of regulation. Regulators at all levels were perplexed at how they could regulate an activity, which happened everywhere, but nowhere. Yet with time, both municipal and international law has been able to keep pace with technological progress, until the arrival of the blockchain.

Why Blockchain Cannot be a Terra Nullis

Blockchain-based platforms are unique since they allow buyers and sellers to directly deal with each other. The greatest forte of blockchain is eliminating the role of trusted third party intermediary to authenticate transactions and establish ‘trust’ between users. However, in case a dispute occurs, this very asset has to the potential to be blockchain’s greatest liability.

Since the blockchain has no intermediaries, there exists no authority to settle disputes arising between the parties. For instance, in regular transactions, if a person claims that their account credentials were stolen and money was transferred from their account, then the bank, which performs the role of an intermediary, can resolve it. However, if the same situation occurs in any blockchain-enabled platform, there exists no mechanism to settle the dispute. This lack of regulation and a mechanism for speedy resolution of conflicts between users would undermine the trust inherent in the blockchain technology.

Since its inception, the extra-territorial nature of the internet has been considered a threat to the traditional conception of the sovereignty of the state.[1] However, it should be kept in mind that blockchain is not the first instance of conflict between sovereign jurisdictions. Well before the advent of the Internet, problems related to the regulation of television, telephone, and financial services had highlighted the urgency of ‘shared sovereignty’, or at least, a shared agreement between the two affected countries.[2] The Internet has not produced a global borderless network but rather “a collection of nation-state networks—networks still linked by the Internet protocol, but for many purposes separate”.[3]

Need for Transnational Law Over Regional Legislations

Like blockchain, the concept of transnational law is new to the legal spectrum. Coined by an eminent jurist, Philip Jessup, transnational law can be defined as to “…include all law which regulates actions or events that transcend national frontiers”.[4] It is the law of non-state governance systems.

Public international law deals mainly with, but is not confined to, States and its instruments; while, private international law occupies itself with disputes between private individuals and entities located in different jurisdictions. Transnational law, like blockchain, resides in the grey area between public and private international law. Potential blockchain dispute resolution can entail conflicts both at municipal and transnational levels and include not only private individuals and corporations, but also international organisations, states and their agencies, organisations of states, or other groups.[5]

National law continues to play a crucial role, even if the events in a blockchain transcend borders. The inability of the government to control blockchain at the border does not mean that it is beyond municipal regulation.[6] If it is not possible to intercept the content at the border, a nation can take many steps within its territory to regulate indirectly content transmitted from abroad. Generally, this happens through the adoption of legal sanctions against the foreign content provider’s local assets or agents.[7] However, this cannot be done in blockchain technology. No technical means could allow Internet service providers to control and select users having access to a certain website depending on their country of origin. States can still target chokepoints in their infrastructure to exert control in the same way governments have targeted intermediaries like search engines and ISPs to tame unruly aspects of the Internet. Like in most technological breakthroughs, the States have been slow to turn their attention to the growing clout of the blockchain. They have adopted a policy of ‘precautionary monitoring’ rather than pre-emptive regulation.

However, developing regional laws without the backdrop of an international law has severe drawbacks. With a patchwork of municipal laws asserting conflicting and concurrent jurisdictions, international harmonisation may become a herculean task, for instance, the conflict between USA and Europe in contradictory regulatory approach towards Genetically Modified (hereinafter ‘GM’) crops.

The regulation of a transnational phenomenon like blockchain cannot be explained without ‘lex mercatoria’. During medieval times, trade was governed by a set of rules and customs particular to a kingdom. However, with the advances of transportation, trade expanded into foreign lands where domestic laws had little application. The indigenous nobles’ judicial experience was limited to land claims and they could not adjudicate on a ‘sphere of activity that he barely understood and that was executed in locations beyond his control’.[8] This jurisdictional confusion gave birth to a new set of laws called ‘lex mercatoria’ or the Law of the Merchants. The law was evolved by the merchants themselves to regulate different types of transactions and was enforced by special merchant run courts.[9] Over time, they were recognised as a customary body of law for interregional commerce and were absorbed into English and American legal system, where it was later codified.

Today, choice of law clauses permit harmonisation of international commercial law by specifying that the substantive legal rules used to resolve the dispute may encompass, via the lex mercatoria, general principles of law and the customs and practices of international trade rather than the substantive contract law of any particular state.[10]

If foreign jurisdictions have the power to adjudicate disputes arising out of online activities, it has to be questioned how the judgments delivered in said cases could effectively be enforced. Enforcement of foreign judgements is often complex and sometimes impossible due to the conflict of legal protections under the two regimes. In the Yahoo-Licra conflict, when the French Tribunal refused to permit Yahoo! to auction Nazi memorabilia since it violated the French Criminal Court, but the U.S. District Court refused to uphold the verdict since it clashed with the protection under the First Amendment. Yahoo! did nothing but display on the home page the warning that the website was in violation of the French Criminal Code.

It would be preferable if any action on the internet could be covered by the same set of rules across the globe – an international Internet Law – so that it would not matter where the case was brought. An ideal approach here would be the development of a decentralised alternative to the current legal system – a form of digital common law. It should be an ‘interconnected set of rules’ that interact with one another in a reliable and predictable manner, without the need of any third party institution to enforce them. Departing from the existing legal framework, whose provisions are universally applicable, under this new paradigm, participants would be free to select a regulatory framework, which better reflects their underlying preferences and needs, the contextual circumstances and contingencies.

Jurisdictional Issues

The purpose behind a transnational law regarding blockchain is twofold; first, to govern this nascent technology and second, to confer a right of remedy to blockchain users in case of dispute. Now, a right has little value unless it can be enforced.[11] Therefore, the determination of applicable laws and competent forum to adjudicate blockchain disputes is crucial to maintaining trust.

The concept of jurisdiction assumes great importance since it creates, alters, and terminates legal relationships and obligations.[12] Jurisdiction can be defined both as a ‘government’s power to exercise authority over all persons and things within its territory’ and a ‘court’s power to decide a case or issue a decree’.[13] This chapter will examine the problems blockchain disputes will face in determining territorial, personal, and subject matter jurisdiction.

THE PROBLEM OF NODES IN MULTIPLE JURISDICTIONS

The principal idea behind the Distributed Ledger Technology (DLT) underpinning Blockchain is that the ledger shall be ‘distributed’ between all the nodes. There is no concrete method to pinpoint the actual location of the ledger. This characteristic poses a complex jurisdictional challenge. Firstly, since the nodes are located in different jurisdictions, they may be subject to conflicting legal frameworks, and secondly, there shall be no ‘residence’ country for the software due to the lack of a physical location of the ledger.

The transnational nature of a blockchain transaction makes it very difficult to firstly, determine the applicable laws and secondly, select a competent forum to exercise jurisdiction over blockchain disputes. It will be a herculean task for any national regulator to enforce their laws against a blockchain user, transaction or scheme due to the cross-border reach of the technology.

Applicable Laws

In traditional databases, it is not difficult to identify its location, which in turn, determines the application of the appropriate laws and the regulatory authorities. However, this strategy cannot be applied to blockchain technology. In a permissionless blockchain, the participant nodes are ‘distributed’ across several countries or across different states within the same country. Each of the nation states would, therefore, seek to assert its jurisdiction over a potential blockchain dispute, since the nodes are physically present within their territory.

Firstly, this will force the blockchain platform to comply with an unwieldy number of varying and perhaps conflicting regulatory regimes, and is likely to expose the creators, as well as the users of the blockchain, to lawsuits in multiple jurisdictions. Secondly, it is debatable as to how many nodes need to be present in a country’s territory for its Court to claim personal jurisdiction over the database. It is unclear if the presence of a single node will confer personal jurisdiction, or in case of multiple nodes, the presence of a fixed number of nodes in the country or state be required. These confusions will jeopardise the efficiency of the distributed ledger or, worse, render it useless.

Blockchain can avoid such jurisdictional issues by maintaining its ledger only on nodes located within the same jurisdiction. However, this would rob it of its most valuable asset – the ability to transact across borders without any intervention by a third party. Since cyberspace surpasses all territorial boundaries and information can be accessed from unknown locations, geographical borders should not apply in determination of the proper jurisdiction for blockchain disputes. The ideal solution here would be for the blockchain platform to lay down the applicable law and jurisdiction that will apply to all nodes on the network. The blockchain-based service providers should require the participants to agree to a governing law and jurisdiction to access the blockchain solution; in the same manner as certain websites require users to agree to its ‘terms of use’. Similarly, in a private blockchain, users may be required to sign up to specific terms of service.

Competent Forum

The method for determination of a forum to adjudicate a blockchain dispute is not yet clear. Firstly, with no intermediary in the blockchain network, one has to rely on external agencies to adjudicate blockchain disputes. This becomes problematic due to not only conflicting sovereignty but also lack of knowledge regarding blockchain. Secondly, it is undecided whether the forum shall be determined according to the location of the concerned parties, or the location of the relevant nodes. Jurisdictional issues will form an integral issue in blockchain disputes until a clear mechanism is established to determine the ‘residence’ of a distributed ledger for jurisdictional purposes. The blockchain is likely to trigger the problems amplified by the advent of the Internet: should we apply the ‘lex loci delicti’, the ‘lex loci contractus’, the ‘lex loci rei sitae’ or the ‘lex loci protectionis’?

No Central Figure to Hold Liable

No alteration can occur in the ledger without the positive consensus of all the nodes on the network. No single user controls the outcome of the ledger. Though this lack of a centralised point of control guarantees immutability and security, it creates serious problems in pinpointing liability in case of a dispute. In case of any malfunction or data theft from the blockchain, it is unclear who should be held liable – the owner and/or operator of the blockchain, the software developer, all the nodes in the network, whose verification was granted for the transaction, or only the hacker. This paper will study this conundrum through DAO and smart contracts.

THE AMBIGUOUS LEGAL STATUS OF DAO

A DAO or Decentralised autonomous organisation is a computer program run on a blockchain platform and operates through smart contracts. Bitcoin is the best example of a DAO. Currently, DAOs are not recognised as legal entities. This creates uncertainty as to the rights and obligations attributable to a DAO.

Running on the peer-to-peer consensus-based network of the blockchain, DAOs render traditional concepts of ownership and liability redundant. One theory is that in the absence of any formative document or articles, the Courts can treat DAOs as a general partnership or joint venture to fix the onus of responsibility. This would, however, mean that all the participants in the network could be held jointly and severally liable as representatives of the DAO’s interests. Thus, the participants in a DAO may have unlimited potential liability for the entity’s actions. The lack of regulatory recognition will ultimately hinder the utility and popularity of DAO.

Another issue is the legal status of the blockchain ledger. When virtual currencies and smart assets are being exchanged over the blockchain network, the records of these transactions should act as proof of ownership of such assets. However, under existing regulations, records in the blockchain do not confer any ‘legal title’ and therefore have no weight in a court of law. It is ill defined whether the elements recorded in a blockchain are a piece of evidence of a legal act or a fact, though some countries, like France, have started to recognise the legal effect of records in blockchain technology.

The Problem of Anonymity

For many participants, the most attractive feature of blockchain is its unfettered and anonymous participation. Despite its inherent transparency, the blockchain system can be best described as being ‘pseudo-anonymous’. Though all the transactions and entries are public, the user nodes are only known by their ‘virtual addresses’. These virtual addresses are a sequence of letters and numbers in the form of a code and cannot be traced back to reveal the identity of the actual user. Therefore, blockchain enabled transactions may be more transparent than cash but are more anonymous than any other forms of online payment. This stringent anonymity poses significant risks with respect to cryptocurrencies, but is not limited to them.

SMART CONTRACTS: SMART ENOUGH?

A contract is an agreement between two parties to perform (or abstain from) specific acts. It is important because it is legally enforceable in a court of law. So, what makes a contract ‘smart’? If it executes and enforces itself.

Smart contract is a revolutionary technology. They are pre-programmed computer codes inside the blockchain platform that store contractual agreements, which are automatically executed when certain specified criteria coded into the contract are met. For instance, a blockchain can distribute dividends to shareholders of a company according to pre-coded smart contracts. Alternatively, in the event of a flight delay or an earthquake, an insurer’s blockchain can consult a third-party server (‘oracle’) to obtain information and arrange payouts. This makes smart contracts essentially self-executing contractual provisions. A good smart contract, therefore, guarantees a lack of ambiguity of its terms thereby reducing the risk of disagreement.

Smart contracts are truly transnational instruments as they are executed uniformly across the globe, irrespective of differing national laws. They pose two complex legal issues; firstly, regarding their ambiguous legal status, and secondly, enforceability. The legal status of ‘smart contracts’ is yet to be defined. Firstly, the term ‘contract’ invites traditional concepts such as offer and acceptance, consent and consideration, which are irrelevant to many coded programs. Secondly, the principles of contract and title differ across countries. Hence, identifying a law to govern smart contract-related disputes is paramount to the flourishing of blockchain technology.

The easiest option is to modify the existing legal framework governing electronic contracts and apply it to smart contracts. E-contracts have been in vogue for some time and have been accorded legal status and validity by regulatory regimes across the globe. Even, the U.S. 7th Circuit Court had stated that “While new commerce on the Internet has exposed Courts to many new situations, it has not fundamentally changed the principles of contract.”

However, this observation does not hold true regarding smart contracts. Smart contracts and electronic contracts are two very different creatures, albeit sharing similar origin and objectives. The principal distinguishing factor is that while in E-contracts, the agreement is embodied in words, which both parties can read; in smart contracts, the agreement is embodied in a computer code. This distinction makes it difficult to prove informed consent of the users.

A smart contract, therefore, makes it difficult to prove the ‘consent’ of the parties. In a clickwrap agreement (a form of electronic contract), the user is assumed to have read all the ‘terms and conditions’ and agreed to them when she clicks “OK” or “I agree”.  As long as the terms are not hidden or deceptive, common law places the duty to read the online terms on users. This holding is in conformity with traditional contract law which mandates that persons signing the contract would be bound by it, irrespective of whether they have read it or not. Additionally, the complex nature of blockchain smart contracts makes it hard for users to understand what terms they are agreeing to.

The most relevant legislation that can be referred to is the UNCITRAL laws since they are drafted in accordance with the fundamental principles of ‘non-discrimination’, ‘technological neutrality’, and ‘functional equivalence’. The principal of ‘non-discrimination’ ensures that a document is not denied legal effect, solely because it is in the electronic form. This can aid in establishing the legal status of smart contracts. ‘Technological neutrality’ mandates that provisions be neutral to technology so that it may be applied to the upcoming technological advances without further legislative work. The only problem occurs with the principal of ‘functional equivalence’ which mandates that electronic communications should be equivalent to paper-based communications, i.e.. for a contract to be valid it has to be in writing and signed. This is the only significant criterion that the smart contract fails to satisfy.

Theoretically, there is no way of breaching a ‘smart’ contract. However, the reality is not so. The worst example is of the hack that occurred in The DAO in 2016, a decentralised investing platform controlled by its shareholders, who voted based on their stakes on a blockchain. However, soon after raising $150 million as funds, about $40 million were diverted by a hack.

THE WAY FORWARD

Blockchain is a paradigm example of a delocalised global phenomenon. However, is it the panacea to most of the world’s security and trust deficit? Those working to liberate individuals from the whims of governments and corporations could wind up surrendering themselves (and others) to the whims of a much more powerful entity: ‘autonomous code’.

It is a debatable matter whether blockchain is a villain or an anti-hero. However, what is certain is that currently no international legal framework exists tailored especially for blockchain technologies and applications. Regulatory responses should be commensurate with the risks associated with BC technology without stifling innovation.

The law of the Internet demonstrates that the advent of the era of ‘transnationalism’ does not imply the end of the role of national law, but only implies it has to be re-thought in the broader context of globalisation of legal systems.[14]

[1] Oreste Pollicino & Marco Bassini, ‘Internet law in the era of transnational Law’ (2011) European University Institute Robert Schuman Centre for Advanced Studies Working Paper No 24/2011, 12 accessed 31 January 2019.

[2] ibid 13.

[3] Jack Goldsmith & Tim Wu, Who Controls the Internet? Illusions of a Borderless World (1st edn, Oxford University Press 2006) 142-61.

[4] Philip Jessup, Transnational Law (Yale University Press 1956) 1-8.

[5] ibid.

[6] Oreste Pollicino (n 1) 15.

[7] ibid.

[8] David Johnson & David Post, ‘Law and Borders-the Rise of Law in Cyberspace’ (1996) 48 Stan LR 1367, 1389.

[9] Fabrizio Marrella & Christopher S Yoo, ‘Is Open Source Software the New Lex Mercatoria?’ (2007) 47 Va J Int’l Law 807, 811-12 (2007).

[10] Fabrizio Marrella (n 9) 816.

[11] John Locke, ‘The Second Treatise of Civil Government’ (1689) 108.

[12] Malcolm Shaw, ‘International Law’ (4th edn, Cambridge University Press 1997) 452.

[13] ‘Black’s Law Dictionary’ (Bryan A Garner ed, 10 edn, Thomson Reuters 2014) 980.

[14] Oreste Pollicino (n 1).


(Rabindra is currently a student at National Law University Odisha.)

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s