Legal Boundaries of Blockchain Technologies: Smart Contracts as Self-Help

Blockchain technologies promise to execute tasks that have traditionally been settled by legal institutions. Some providers of such technologies explicitly offer ‘to act as a digital jurisdiction’ Such promises seem to suggest that state law can be entirely substituted by rules which are codified in the blockchain. In fact, so-called smart contracts create agreements that are both automatable by computers and enforceable via the tamper-proof execution of computer codes. Lawrence Lessig’s frequently cited equation therefore claims that ‘code is law’. Presumably, however, law is not – and arguably never will be – entirely redundant, even in a blockchainized world.

A key challenge of our times is therefore to identify the legal boundaries of smart contracts and to develop conflict rules for divergences between state law and technology-based code. Even if smart contracts are technologically self-executing, they are not necessarily legally enforceable. Rather, they must satisfy a variety of legal requirements. In a recent book chapter, I aim to identify the legal boundaries of blockchain-based smart contracts. The contribution outlines the regulatory character of smart contracts and blockchain technologies in order to describe potential conflicts in the relationship between technological and legal arrangements, and to consider rules on how to solve these conflicts. Two different levels of rules are differentiated: rules of recognition and substantive restrictions. At both levels, it emerges that either the lawmaker can intervene and introduce new, specific rules, or the judiciary can develop rules on the basis of existing and more general legal standards. For example, at the European level the Unfair Terms Directive and the (future) Directive on Contracts for the Supply of Digital Content limit the potential scope of smart contracts.

At the national level, the rules on self-help constitute a crucial legal boundary. These rules threaten to pose a nearly insurmountable obstacle to many applications of smart contracts. The self-executing character of smart contracts conflicts with the state monopoly on the use of force. Self-execution is a functional alternative to the traditional enforcement by State instutions such as courts or administrative bodies. In contrast, self-execution os of a purely private nature and typically moves the burden of enforcement to the other party. Enforcement, however, is in principle regarded as a public privilege. While the modern conception of the state has been built on the idea that the state alone has the right to use or authorize the use of physical force, smart contracts also involve some degree of physical force, for instance if residents are locked out or if leased cars are locked by starter interrupt devices.

Self-help remedies are not outright illegal, however. Under certain conditions, legal systems typically allow individuals to implement their rights without resorting to state authorities. In this vein, most European private laws regard certain forms of self-help remedies as legitimate, but these rules and their preconditions have not yet been harmonized. Under German law, for instance, self-help is prohibited by law, and parties are regularly not even allowed to waive this prohibition by mutual agreement. In the case of cross-border situations, the comparative divergence of self-help rules will create legal uncertainty and may hinder the use of smart contracts. All the more important is the work on a comprehensive, European strategy for distributed ledger and blockchain technologies. Such work has been announced, for instance, in the FinTech Action Plan, but it will require the tremendous task of taking ‘into account all relevant legal implications’ (Action Plan,  2). The legal boundaries of blockchain technology are so diverse that a great variety of rules of general private law will have to be considered. In particular, national rules on self-help are crucial, but have hitherto withstood all European harmonization efforts, not least because they reflect the state monopoly on force. Enabling smart contracts will therefore be a real challenge for future legal harmonization in Europe, but is nonetheless key for the Digital Single Market.

Florian Möslein is a Professor of Law at the Philipps-University Marburg, Germany