Utkarsh Routh [1]
In recent years, the field of arbitration has undergone significant evolution propelled by technological advancements. Two transformative technologies, blockchain and smart contracts, have emerged as pivotal forces reshaping traditional dispute-resolution mechanisms. The increasing adoption of blockchain technology, particularly in commercial transactions and smart contracts, has introduced novel complexities and challenges in resolving disputes within this digital ecosystem. The concept of blockchain technology, once considered distant for developing countries like India, has now become a significant point of interest for the Indian government, as evidenced by the release of the "National Strategy on Blockchain" by the Ministry of Electronics and Information Technology in December 2021.
This article delves into the intersection of blockchain technology and arbitration, exploring how smart contracts and blockchains are revolutionising dispute resolution within the legal framework of arbitration in India. This article begins by examining the fundamentals of blockchain technology and the workings of smart contracts to provide a comprehensive understanding of the topic. Subsequently, this article analyses the impact of smart contracts, their legal validity, and the incorporation of blockchain in arbitration processes from an Indian legal perspective, emphasising the need for a regulatory framework that can adapt to the unique characteristics of these technologies. Through these insights, this article aims to provide a comprehensive understanding of the evolving landscape of arbitration in the digital age and to propose a new and improved approach for adopting these technologies and capitalising on their benefits in dispute resolution within the permissible limits of the law.
I. Understanding the concept of Block Chains
Blockchains represent novel databases that facilitate the creation and distribution of ledgers or databases across multiple nodes or participating computers. The fundamental characteristic distinguishing blockchains is "disintermediation." Disintermediation entails various parties sharing a single database and achieving a unified perspective of the subject matter without any individual party assuming control over the data. This concept can be likened to a soccer game without a referee. In such a scenario, players collectively maintain the score and adjudicate fouls by reviewing replays and voting, replicating the decisions typically made by a referee. Consequently, blockchain obviates the need for a central authority and instead relies on the participating nodes, akin to the players in the soccer analogy. Blockchains “can efficiently record transactions between two parties in a verifiable and permanent way.”
In simpler terms, a blockchain can be described as follows:
· A Database: It operates like a ledger, constantly expanding as new entries or transactions are added.
· Distributed: Copies of the entire database are stored on numerous computers across a network, ensuring synchronisation within minutes or even seconds.
· Transparent: Records stored in the database can be made visible to relevant stakeholders without the risk of unauthorised alterations.
· Secure: Unlike traditional databases, where malicious actors can target a single computer to tamper with records, blockchains provide heightened security measures.
· Immutable: Thanks to complex mathematical algorithms, once data is recorded and accepted, it becomes practically impossible to alter or delete.
II. Elucidating the functioning of Smart Contracts
Blockchains facilitate the development of "smart contracts," which are characterised as self-executing contracts where the terms of the agreement between parties are directly encoded into lines of code. These contracts, along with the associated agreements, are distributed across a decentralised blockchain network. The code governs the execution of the contract, and transactions conducted through smart contracts are both traceable and irreversible.
Smart contracts are essentially coded representations of agreements between parties. A smart contract is essentially a self-executing code that operates based on predetermined conditions agreed upon by the parties involved. In essence, they follow a deterministic logic: if the event "x" happens, then execute action "y." Consequently, the functions performed by smart contracts are relatively straightforward, typically involving tasks like automatically transferring a specified amount of money from one party's wallet to another once predetermined conditions are met. To illustrate, consider a basic example involving an insurance smart contract. Imagine purchasing insurance for a flight delay. In this scenario, the smart contract would contain data parameters to determine whether the flight was delayed and if you were onboard. If the conditions are met, such as the flight being late, the insurance payout will automatically be disbursed to you as the passenger.
Let's revisit our analogy of the soccer game. In this scenario, the players opt not to manually update the database with each foul's consequence. Instead, they establish a system where certain actions trigger automatic consequences, therefore bringing the concept of smart contracts into the frame. For example, if a player commits a handball, it results in a foul and possession of the ball transfers to the opposing team. The players can configure the system to record these consequences automatically. For instance, if Player xyz prevents a goal by using their hand, Team B is awarded one point. Each time such an incident occurs, the system promptly credits Team B with a point. This mechanism, which identifies fouls and enforces their consequences, operates akin to a smart contract.
III. Deducing The Validity of Smart Contracts in The Indian Legal Paradigm
In Indian legislation, contracts are governed by the Indian Contract Act of 1872, which establishes the legal framework for agreements. Section 10 of the Contract Act stipulates that all agreements are contracts if they are entered into by parties with free consent, for a lawful consideration, and with a lawful object. Put simply, for an agreement to be enforceable under this Act, it must involve an offer, acceptance, and consideration.
Smart contracts, existing in a coded form, inherently include the elements of offer and acceptance. This can be demonstrated by drawing a parallel analysis between the Indian Contract Act of 1872 and smart contracts, as follows. As per section 2(a) – “When one person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to make a "proposal”:” and therefore, in the context of smart contracts, the act of publishing the self-executing code represents the intention of one party to enter into a contract with another party, thereby constituting an offer. Moreover, according to section 2(b) - When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a "promise." Simultaneously, in smart contracts, it is a prerequisite that the other party performs specific pre- determined actions as outlined by the contract. Upon the completion of these prescribed actions, the offer is considered to be accepted. Furthermore, the Contract Act establishes a mandatory element of consensus ad idem (which means an agreement for the same thing) for a contract to be valid. In smart contracts, this is achieved when the parties mutually agree to the code and activate or initiate the contract. Therefore, activating/triggering the smart contract meets the consensus ad idem requirement, resulting in a valid contract. This typically involves agreeing to the terms and conditions of a specific service platform that facilitates the transaction. That being said, while the elements of offer and acceptance are easily met in smart contracts, the real challenge lies in establishing the element of consideration.
IV. Smart Contracts in Block Chain Arbitration: The Crypto Currency Conundrum
As the majority of the transactions in the blockchain arbitration platforms take place in cryptocurrency, therefore, a question arises as to whether the Contract Act of 1872 would recognise a cryptocurrency such as Ethereum as a valid form of consideration, particularly in the absence of specific regulatory frameworks. This remains a contentious issue in India. However, an alternative to conventional consideration can be found in Section 2(d) of the Contract Act of 1872, which mandates a reciprocal promise or action by the promisee for consideration to be deemed valid. Nevertheless, the struggle for the proper recognition of cryptocurrencies as consideration persists. Complicating matters further and impeding the advancement of virtual currencies, the Reserve Bank of India (RBI) in 2018 imposed a ban on cryptocurrency trading in India. This presented significant challenges to the implementation of smart contracts that involve cryptocurrencies as a form of consideration within the Indian legal framework. However, a significant development occurred on March 4, 2020, when a three-judge bench of the Supreme Court overturned the ban, hinting at the potential recognition of cryptocurrencies as valid consideration under the law.
The recent decision has set the stage for a more favourable environment for blockchain arbitration in India, as many decentralised dispute resolution platforms in the blockchain space use cryptocurrencies as a form of payment for their services. Therefore, this judgement opens up the possibility of using smart contracts and these decentralised dispute resolution platforms for any dispute arising out of such smart contracts in India.
V. Legal Validity of Smart Contracts in International Regime
VI. Evaluating the scope of dispute resolution in Smart Contracts?
Smart contracts possess the capability to incorporate preprogrammed actions for non-compliance and enforce automatic mechanisms. Some argue that these sophisticated contracts could potentially eliminate the necessity for third-party intermediaries like arbitrators or judges. However, this notion needs to be revised. Firstly, as previously discussed, a smart contract is not a legal contract but rather a piece of code, thus limiting its scope of action. Suggesting that a smart contract could serve as an automated remedy provider for contract breaches and supplant arbitrators or judges is simply implausible. Secondly, there is a misguided belief that parties can anticipate every conceivable outcome of a contract. In reality, this presumption is atrocious, as it would require the smart contract's code to encompass all possible scenarios and automatically trigger preprogrammed responses. The requirement for predictability as a precondition for smart contracts to replace dispute resolution mechanisms and judges highlights the limited applicability of replaceable contractual relationships. Smart contracts become ineffective when faced with uncertainty regarding the outcome of factual scenarios, such as the interpretation of events that happened outside the ambit of the contract.
For example, suppose there is a force majeure clause in a contract that defines the happening of an event as force majeure based on three different criteria: Non-political events, indirect political events, and political events.
For these events, a cost allocation clause was laid down below.
a) for a Non-Political event – the parties will bear their respective costs.
b) for an Indirect Political event – if the costs exceed the insurance cover for such an event, the concessionaire will bear the costs up to half of the excess, and the other half of the excess would be reimbursed by the authority; and
c) for a political event – all costs attributable to political events will be reimbursed by the authority.
Now, supposedly, In the wake of a global pandemic, many contracts are being examined for their force majeure clauses, which excuse parties from fulfilling obligations due to uncontrollable events. The pandemic has ignited debates on cost allocation and whether it is a political or non-political event. As most contracts likely did not anticipate a pandemic of this scale, disputes are expected over the interpretation and applicability of these clauses, resulting in the failure of the smart contract’s mechanism. Furthermore, contract law often involves broad legal concepts such as "good faith" and "reasonableness," necessitating flexibility, interpretation, and contextual analysis. The correct application of these concepts in fully automated smart contracts poses a challenge.
While smart contracts excel in automatically executing programmed tasks, they are unable to render subjective judgments or incorporate external elements beyond the blockchain. For example, smart contracts can very well verify whether the goods under a contract were delivered by the seller to the buyer and, therefore, automatically make the payment for such goods. However, when it comes to disputes such as the quality of goods delivered, smart contracts render themselves useless, and therefore, implementing a dispute resolution mechanism is crucial. This leads to another important question: should we use litigation or blockchain arbitration as the suitable means for dispute resolution?
VII. The Incompatibility of Traditional Litigation with Blockchain Disputes: A Call for Innovative Approaches
The idea that litigation could effectively resolve disputes related to smart contracts or blockchain technologies seems far-fetched as the traditional legal frameworks, which particularly emphasise physical and territorial aspects, are ill-suited for the decentralised nature of blockchain. This mismatch arises because blockchain operates beyond physical boundaries, challenging the applicability of conventional legal principles.
Upon examining alternatives to litigation, such as arbitration, it's clear that both routes encounter distinct challenges in the context of blockchain. However, a deeper comparative analysis reveals that litigation, in particular, might be less adept at addressing these disputes efficiently. This inefficiency arises not merely from the mismatch between the decentralised essence of blockchain and the localised nature of traditional legal processes but also from practical complications in litigation, such as the irreversible nature of smart contracts, which pose a significant challenge as court orders will not be effective on its terms. Moreover, litigation is burdened by issues such as time constraints, high costs, limited technological expertise, and challenges in international enforcement, rendering it ill-suited for resolving disputes related to smart contracts.
The challenges extend to arbitration as well – a method that traditionally offers more flexibility than litigation. The concept of the seat of arbitration is a legal concept referring to the jurisdiction in which the arbitration is deemed to take place. Determining the seat of arbitration is pivotal because it influences the procedural conduct and can significantly affect the outcome, or the enforceability, of the arbitral award. In the realm of blockchain, where transactions and disputes inherently lack a physical or territorial anchor, pinpointing a seat of arbitration aligns poorly with the technology's borderless nature.
Thus, while both litigation and arbitration face obstacles in effectively resolving blockchain-related disputes, the inadequacies of litigation are particularly pronounced. On the contrary, the arbitration framework offers a more robust approach and can provide practical solutions to the challenges encountered in litigation. However, traditional arbitration methods are often deemed overly formal, time-consuming, and costly, particularly in the context of low-value disputes. The decentralised, global essence of blockchain demands dispute resolution mechanisms that transcend traditional, geographically bound legal structures. This scenario underscores the need for innovative legal approaches that harmonise with the unique characteristics of blockchain technology, advocating for a rethink of how we handle such disputes in the new digital age. Hence, a novel segment of dispute resolution systems has emerged, exemplified by blockchain-based, crowd-sourced online dispute resolution systems. While bearing some resemblance to arbitration mechanisms, labelling them as a definitive method of arbitration would be inaccurate.
VIII. Decoding Decentralised Justice – Crowd-Sourced Dispute Resolution System?
Decentralised justice is a new approach to online dispute resolution that combines blockchain, crowdsourcing, and game theory to produce dispute resolution systems that are radically more efficient than existing methods. It refers to any blockchain-based, crowdsourced online dispute resolution system (Hereinafter referred to as CSDRS) that resorts to many crowdsourced jurors to decide on cases. Decentralised justice systems incentivise jurors based on game theory principles.
The Escrow Dapp contains a feature that asks each party whether the other fully complied with the contract. If the parties answer in the affirmative, then Kleros releases the funds held in escrow to the receiving party. If, however, a party answers in the negative, then in order to trigger the arbitration mechanism and have the dispute referred to a Kleros jury, the parties need to pay the arbitration fee and the corresponding gas fee. The arbitration fee is the payment Kleros jurors receive for rendering a coherent (majority) decision in the dispute; it is reserved only for coherent jurors, and incoherent jurors receive no portion of it. Both parties must pay the arbitration fee by a certain deadline; otherwise, the non-paying party will automatically lose the dispute. While the arbitration fee is initially paid by both parties to trigger the arbitration process, the winning party is reimbursed their portion of the arbitration fee. Therefore, the arbitration fee is ultimately paid only by the losing party to the coherent jurors. One example of the same would be –
• Escrow: To pay for an off-chain good or service, the funds can be put in a smart contract. After receiving the good or service, the buyer can unlock the funds to the seller. In case of dispute, Kleros can be used to have the smart contract either reimburse the buyer or pay the seller. Such a Kleros-based escrow system is already available For a much clear understanding, read (Kleros, a Decentralized Court System for the Internet)
Within Kleros, arbitrators are referred to as "jurors." Each juror is mandated to stake a specific amount of PNK as an entry fee in a Kleros court. Each Kleros court has its own threshold for the minimum amount of PNK that must be staked to enter the pool. The platform based on the concept of game theory employs a proof of stake mechanism, where the likelihood of a juror being selected is determined by the quantity of PNK they stake. In essence, the more tokens a juror stakes, the higher their chances of being chosen. Decentralised justice systems typically maintain anonymity regarding the identity of jurors. This can be simplified as an online dispute resolution system, where parties present facts and evidence to anonymous jurors. These jurors base their decisions solely on the materials provided. Jurors must vote with the majority, or "coherent jurors," to retain their deposit tokens; otherwise, it get forfeited. The pool amount is then distributed among the coherent jurors as an award for their decision. This mechanism incentivises jurors to vote reasonably.
IX. Decentralised Justice – Analogous To Traditional Arbitration?
There are inherent challenges in categorising the decentralised justice system as a definitive form of arbitration. While it certainly serves as a notable alternative dispute resolution system, its similarities to traditional arbitration are subject to debate. To refer to decentralised justice as blockchain arbitration is misleading and confusing and should be avoided.
In both contract law and the Arbitration Act, identifying the parties involved is crucial for contract enforcement, particularly in arbitration agreements. This is emphasised by the requirements of the Evidence Act, alongside sections 7(4)(a) And 8 of the Arbitration Act. However, in a system where parties are anonymous due to coding, determining the individuals or entities in a dispute, especially regarding breaches or terminations of smart contracts, becomes complex and poses challenges in adhering to specific sections of the Arbitration Act.
Moreover, concerning the validity of arbitration agreements, the New York Convention on the Enforcement of Foreign Arbitral Awards, endorsed by 166 nations, mandates that such agreements must be in written form and signed by the parties. This criterion is also mirrored in the Arbitration Act of 1996. The question arises regarding whether digital code can be considered as documentation in court, particularly in cases where there is no valid written arbitration agreement, which remains a topic of contention. Although the UNCITRAL Model Law on International Commercial Arbitration permits electronic agreements, it does not explicitly address blockchain technology, leading to uncertainty in this area.
Moreover, in the realm of international arbitration, the New York Convention only acknowledges the enforceability of foreign arbitral awards if they are rendered in a territory different from where their recognition and enforceability are sought. Since blockchain arbitration platforms operate as decentralised applications solely in a digital environment, they do not fall within the jurisdiction of any specific state territory. Consequently, their decisions lie outside the scope of the New York Convention and, by extension, the Arbitration and Conciliation Act 1996. Adding to the complexity, decisions rendered by platforms like Kleros, utilising crowd-sourcing dispute resolution systems, fail to meet the criteria of an arbitral award as defined in section 31 of the Arbitration Act of 1996. In simple terms, they lack the names and signatures of the parties or the arbitrators (jurors), are not documented in writing (as mentioned earlier), and crucially, do not designate a seat of arbitration. Finally, it's essential for parties to receive copies of awards signed by the arbitrators. However, in blockchain arbitration, jurors cannot sign the award due to their anonymity, resulting in parties being unable to receive signed copies of the awards.
Furthermore, the post-arbitral proceedings, which are considered pivotal in arbitration as they afford parties the opportunity to challenge awards in court if they are deemed inadequately reasoned or arbitrary, do not apply to decisions rendered by platforms like Kleros. Attention is drawn to Sections 33 and 34 of the Arbitration Act, which addresses the correction and interpretation of arbitral awards, including the possibility of making additional awards and applications for setting aside such awards. Under the blockchain regime, once a decision is rendered, the smart contract triggers the actions it is programmed to perform. Importantly, this mechanism leaves no room for modifying, correcting, or interpreting such awards as outlined in Section 33 of the Arbitration Act, as the execution of the contract takes precedence over any challenges. Additionally, the automated execution of smart contracts concerning the arbitral award precludes the possibility of setting aside the award if either party wishes to contest it.
X. Hybrid Awards – A Way Forward for Blockchain Arbitration in India?
Amidst the pile of challenges faced by the notion of blockchain arbitration, a significant development occurred in September 2020 when a hybrid award was rendered by a Mexican Court. The court successfully integrated a decision rendered by the Kleros platform into an arbitral award, deeming it valid. However, it is pertinent to mention that in the Mexican Kleros case, the arbitration agreement in question was a formal, written agreement, and the agreement did not specify that Kleros should arbitrate the dispute; rather, it designated an arbitrator to arbitrate the dispute. The arbitrator was then tasked with drafting a procedural order containing relevant aspects of the controversy, parties' positions and arguments, and supporting evidence before referring the dispute to Kleros. Additionally, the agreement stipulated that the Kleros decision should be "incorporated" into the arbitrator's decision, emphasising that the award, not the decision, constituted the definitive resolution of the dispute. Consequently, the court did not consider the jurors as arbitrators, and the sole arbitrator's signature was deemed sufficient for the award's validity. Therefore, the decision formed part of the arbitration award, demonstrating that the conventional arbitration procedure addressed the flaws that were associated with the decentralised justice decision. As a result, the Mexican court did not validate decentralised justice proceedings but instead relied on the traditional award, which utilised jurors to make the final decision. This decision underscores the principle of parties' autonomy and their freedom to direct arbitrators in resolving their disputes. The approach taken in Mexico demonstrates a convergence between a domestic legal system and blockchain arbitration, ensuring adherence to the existing lex arbitri.
In the Indian legal framework, we've discussed the potential hurdles regarding blockchain arbitration. However, to overcome these challenges and capitalise on platforms like Kleros, Hybrid Awards can offer a solution. It's important to note that the cornerstone of Arbitration, Party Autonomy, has been acknowledged by Indian Courts as "the brooding and guiding spirit of arbitration." it is also enshrined under section 19, which provides that it is for parties to decide what procedure will be followed by the arbitral tribunal. Furthermore, this concept has been elevated to such an extent that in the Bharat Aluminium Co. v. Kaiser Aluminium Technical Services Inc. (2016) 4 SCC 126 judgment, the Supreme Court affirmed that parties are free to select the governing law for the substantive aspect of the dispute. In fact, parties can even opt to settle. Hencer dispute through unconventional means like a chess game or coin toss, with the arbitrator serving as a referee, as long as it doesn't violate national public policy. Hence, there's every reason for parties to opt for blockchain arbitration platforms to resolve disputes, with the arbitrator subsequently incorporating the outcome into the arbitral award.
XI. Conclusion
Upon thorough analysis, it can be argued that the integration of blockchain technology and smart contracts into the realm of arbitration is inevitable. It's only a matter of time before large corporations start including clauses for blockchain arbitration in their arbitration agreements. However, the current operational model of blockchain arbitration, such as decentralised justice or hybrid awards, fails to fully harness the true benefits of blockchain technology. Decentralised justice, as discussed above, is based on game theory principles and operates in a way that allows the juror who stakes the highest amount of money to adjudicate the matter. In the current landscape, there is a legitimate concern about the potential for companies to influence outcomes by purchasing jurors and tampering with the decisions rendered. The risk of companies paying off jurors to stake high amounts and secure the opportunity to judge a matter, thereby rendering biased judgments, poses a significant and plausible threat. Moreover, hybrid awards represent the primary method to integrate blockchain technology into the Indian legal framework, yet they come with their drawbacks. To begin with, courts are not obligated to uphold decisions made by platform jurors like Kleros, and they may reject the incorporation of such decisions. This rejection can result in wasted resources, including time and money. While this aspect serves to protect the rights of parties, it simultaneously undermines the advantages offered by platforms like Kleros, rendering them potentially redundant.
XII. Suggestion – A New Approach
Integrating blockchain technology with arbitration presents challenges beyond the legal paradigm as well, such as issues of cost, time, and decision accuracy. While decentralised justice platforms offer enhanced security and relative efficiency in facilitating the arbitration processes, they do not fully address these residual concerns. Therefore, the amalgamation of artificial intelligence (AI) into blockchain arbitration presents a compelling opportunity to further enhance the efficiency, accuracy, and effectiveness of blockchain dispute resolution in the context of smart contracts.
1. AI-Enhanced Smart Contracts – Reducing Cost: The author proposes integrating AI more comprehensively with smart contracts, extending beyond basic document analysis because AI systems like Kira can efficiently read contracts, highlight crucial terms, and perform rapid due diligence, significantly reducing the time spent on contract review. While not decision-making tools themselves, these AI systems excel in contract comprehension and analysis, establishing a foundation for more dynamic and responsive agreements. This integration has the potential to reduce ambiguities and significantly decrease the cost and time required for contract review as compared to manual methods.
2. AI Arbitration Assistants – Reducing Time and Increasing Accuracy: The author proposes developing AI arbitration assistants tailored for blockchain environments. These systems would identify critical issues within disputes, analyse relevant precedents from past blockchain transactions and arbitrations, and propose potential pathways based on previous case outcomes and legal principles. A pertinent example of such technology is ROSS Intelligence, a research platform for laws and jurisprudence that offers more intuitive and efficient searches compared to traditional platforms like Westlaw or LexisNexis, SCC Online & Manupatra. While ROSS cannot settle disputes autonomously, it excels at quickly finding relevant laws, cases, and responses to legal queries, providing explanations for its reasoning. By leveraging AI assistants like ROSS in blockchain arbitration, parties could significantly reduce research time for argument preparation. When provided with the right data, AI systems can quickly offer legal precedents to jurors, ensuring that all relevant information is available for the jurors to make their decisions. This could potentially improve the accuracy, integrity and efficiency of the arbitration process.
3. Predictive Analytics for Arbitration Outcomes: The author suggests developing an AI tool for blockchain arbitration modelled after existing systems that predict court decisions. This AI would analyse past arbitration decisions within the blockchain ecosystem to predict potential outcomes. Upon submission of a dispute, the AI would review the facts and evidence, search for similar cases in its database, and provide a reference award. Jurors of the blockchain space could then use this reference to guide their decisions, potentially reducing bias. A comparable AI model for U.S. Supreme Court predictions has achieved 70.2% accuracy in case outcomes and 71.9% accuracy in individual justice votes.[2]
4. Hybrid Human-AI Arbitration Model: To address concerns about the limitations of AI in understanding subjective intent and complex human factors, the author proposes a hybrid model that combines AI capabilities with human oversight. In this approach:
a) AI systems would handle initial analysis, evidence gathering, and preliminary assessments;
b) Human arbitrators would review the AI's findings, conduct further inquiries if necessary, and make the final decision;
c) The AI system would continuously learn from human arbitrators' decisions, improving its accuracy over time.
[1] He is a fifth-year student currently pursuing the B.A LL.B (Hons.) programme at Dr Ram Manohar Lohiya National Law University, Lucknow.
[2] A General Approach for Predicting the Behavior of the Supreme Court of the United States, Daniel Martin Katz, Michael J. Bommarito, and Josh Blackman.
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