Tencent Research Institute: 6 core analysis of contract law of crypto assets and smart contracts

Source: Tencent Research Institute

Author | Yuan Jun Assistant Researcher, Tencent Research Institute

Core feed

1.The law explicitly recognizes crypto assets as tradable property

2. The effect of not having the right to dispose of crypto assets is not invalid

3. The automatic execution of the contract will have an impact on the mandatory performance of the contract and the strict adherence to the contract

4. Contract interpretation distinguishes the code for establishing rights and obligations from the code for execution

5.Inaccuracy of the code may produce meaning indicating error and freedom

6. Digital signatures help verify the authenticity of identity and meet legal signature requirements

Note: This research report comes from an analysis of legal issues of crypto assets and smart contracts issued by the UK's Lawtech Delivery Panel (LTDP) in November 2019. It officially recognizes the legal status of cryptocurrencies and clarifies their property attributes. Lawtech Delivery Panel is a UK-backed organisation that supports the digital transformation of the legal sector with technology. Led by High Court Justice Geoffrey Vos, the organization is committed to providing much-needed market confidence, legal certainty, and predictability for the successful development and use of crypto assets and smart contracts in the global financial services sector.

I. Clear legal status of crypto assets as tradable property

The UK has long established cryptoassets as an important part of its fintech strategy. As early as March 2018, the United Kingdom established a cryptocurrency working group. Since then, it has released a special report to explain the application of policies on crypto assets and distributed bookkeeping technology, and evaluate potential risks and benefits. In January 2019, the Financial Conduct Authority (FCA) of the United Kingdom issued the "Crypto Asset Guide" guidance document to create a sandbox regulatory environment conducive to the development of crypto assets. The official release of the legal statement officially recognizes that crypto assets are tradable property under English and Welsh law, which aims to clarify legal attributes and remove legal obstacles.

The characterization of crypto assets as tradable property needs to consider the impact on the traditional property rights system. The first is that crypto assets cannot be simply classified as intangible or tangible property; the second is that crypto assets' unique intangibility, cryptographic authentication, distributed accounting, decentralization, consensus mechanisms and other unique features are not necessarily incompatible Property characteristics require detailed interpretation rules; Third, crypto assets may have impact on many existing legal rules. Taking distributed accounting as an example, the transactions of crypto assets will spread to the entire network nodes. Once confirmed, it is added to the distributed ledger. The advantage is that the transaction history can be kept reliable, and the same encrypted assets are transferred to different recipients in an inconsistent manner. The impact of this distributed accounting on the legal system is that transaction management rules are not established by contracts or other legally binding methods, but by informal consensus among participants. The consensus mechanism used includes proof of workload (proof -of-work) or proof-of-stake. Fourth, the unique feature of automated transaction execution of crypto assets will impact the ownership system characterized by exclusive use, and even further affect other legal systems, such as mortgages, the implementation of pharmaceutical management agreements, and property ownership under the personal bankruptcy system. The distribution of the rights of the liquidator when the company goes bankrupt.

Although it may have an impact on the traditional property rights system, common law systems, especially English law, can consistently and flexibly respond to this new technology model. The greatest advantage of the common law system is its inherent flexibility. Judges do not have to suffer from cumbersome, time-consuming and inflexible legislative procedures, but can apply existing adjudication principles to new cryptocurrencies by summarizing similar cases.

Second, the effectiveness of crypto assets without the right to dispose is not invalid

A person who masters the principle of a private key and has control over encrypted assets can be regarded as the subject of asset ownership in principle, but the rights subject and the transfer rules must be detailed according to different situations. For example, one person may be an employer or a customer who acts as an intermediary to hold another person's key. In this case, the ownership determination shall be based on the agency and trust rules. There may also be multiple key holders for the same encrypted asset. The asset function shall be referenced to share or divide ownership among the holders; if someone illegally invades the system to obtain Private key, it cannot be considered as the legal owner.

In order to transfer within a crypto asset system, the transferor usually modifies public parameters or generates new parameters in order to create a transfer record. This on-chain transaction transfer method is not equivalent to physical delivery or rights transfer in the legal sense. When a person who has no right to dispose of a property is transferred to another person, the transfer is not considered effective. But crypto assets have their own special features. When the subject who does not own the ownership of the asset has no right to transfer it to a third party, the owner has not lost the ownership or control of the asset, but because the misconduct of the disposition person, the encrypted asset is now considered as used or has been used by the consensus mechanism abolition.

Third, attach importance to the impact of automatic contract execution on contract enforcement and contract strict adherence

Smart contracts are a legal act in nature. An event-driven, stateful computer program that runs on a replicable shared blockchain ledger. The parties coded the agreement and recorded the parties' relationships and specific meanings in a specific block in the form of smart contracts. Once the prescribed state occurs (that is, the state after the parties' rights and obligations are coded), the contract will be triggered to automatically perform the transfer of assets. However, the method of performance involves multiple data statuses, which may be the actual performance of all the terms of the contract, partial performance, and partial breach of contract due to non-performance.

Such an automatic enforcement mechanism would have an impact on the compulsory performance and contract strict compliance in the sense of contract law. From the perspective of mandatory performance, the non-tampering of smart contracts can prevent one party from deliberately failing to perform, thereby automatically executing the contract terms and avoiding repeated disputes between the parties over the terms. But it cannot be ignored that it may impact the enforcement system in modern contract law. Mandatory performance in the sense of contract law is the realization of the content of compulsory creditor's rights with the aid of public powers of the state, and self-help relief is prohibited. If a party directly requests the breaching party to perform the contractual obligations without resorting to the powers of the adjudicating authority, it is still the scope of the first payment obligation, rather than enforced by the contract. From the perspective of the principle of freedom of contract, the automatic execution of the contract eliminates the principle of contract freedom to a certain extent while ensuring that the contract is strictly adhered to. After all, the contract has potential risks such as system design flaws and code running in an uncontrollable manner. Once the contract cannot be arbitrarily interpreted and tampered, it is difficult for the parties to argue in substantive law, and procedural relief is also difficult to apply.

Fourth, the contract interpretation distinguishes the code for establishing rights and obligations from the code for execution

The internal architecture of a smart contract includes a text layer, a code layer, and a base layer. The text layer consists of natural language to reflect the meaning of the code, and the code layer records the contract terms that can be read and executed by the machine. The two complement each other independently.

As the data foundation of smart contracts, contract codes are usually clear and coherent. There is no room for judges to interpret in the context of smart contracts composed of pure codes. But contract codes are not always clear. Judges still have a lot of room for explanation in the case that the transfer of property rights and the transmission of value depend on one party. Because the full text in the contract text layer records all the contract terms and fully describes the meaning of the code, it can supplement the explanation of the code's operating mechanism and other factors beyond the code. The judge can refer to the full text, interpret the contract terms according to the corresponding technical characteristics and business rules, and further infer the parties' true intentions.

The code is not necessarily clear and explicit, but it is also reflected in the code itself. For example, code programs may use ambiguous infrastructure; different compilers (a computer program that converts source code written in a programming language into a target language) have different ways of treating a particular infrastructure; different code runs Order may affect its behavior, and potentially its meaning. Therefore, when explaining the smart contract, the judge will look at the code for setting rights and obligations in the contract as a whole and the code that only performs the function of execution, combined with admissible evidence, to determine the rights and obligations between the parties. In the case of a code setting obligation, the judge needs to find out whether the parties have the will to be bound by the code. When the code is ambiguous or the contract contains code and natural language, you need to focus on external evidence. When the code only involves execution issues, the smart contract need not be involved in the interpretation of terms.

Fifth, review the accuracy of the code, correct errors and unfreedom

To clarify some or all of the contractual obligations between the parties, the judge will focus on the key factors behind the running computer code. After all, in practice, a contract run entirely by code makes it impossible for a party to foresee the meaning behind the terms of the contract. It is difficult to imagine that an agreement will be reached with full reference to running computer code, without reference to natural language or source code. When reviewing the matter behind the code, the judge will first determine whether there is an error or defect in the intention of one or both parties, whether the code truly reflects the true intentions of the two parties to the transaction, and whether there are changes in or withdrawing the sincere intention after the invitation is issued. In case of inconsistency. Secondly, review whether there is a prohibition of serious intentions such as intimidation by one party to express untrue and free freedom, and ensure that the basic principles of contract law such as autonomy of the will and freedom of contract are observed in contract negotiation, conclusion and performance of automated contracts.

6. Digital signatures help verify the authenticity of the identity and meet legal signature requirements

Because statutory signature requirements exist in a variety of legal documents, the parties to a contract are generally considered to have to perform identity verification procedures when entering into a contract. However, the current British law does not require the parties to the contract to fully know the true identity of the other party, and even many successful transactions have been reached without one party knowing the other party ’s true identity. Under such anonymity, smart contracts reached by parties still have Legally binding contractual obligations. For example, the case of high bidders in auctions, single-service contracts, and so on.

In addition, digital signature technology itself facilitates identity authenticity verification to verify the integrity and original origin of digital content. Compared with handwritten signatures, digital signatures have higher complexity and security. We can think of a digital signature as code attached to a message or document. After the digital signature is generated, it can be used as proof that the message has not been tampered with during the transmission from the sender to the receiver, thereby ensuring that the data is complete, immutable, and identity verifiable, and fully meets the legal signature requirements.

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