Blockchain Arbitration – The Future of Dispute Resolution Mechanisms?

In an era where technology is at the forefront of development, smart contracts and blockchain are not new concepts. While the concept of investing nfts into this may be to some, the integration of these concepts with arbitration, a frequently used fora for dispute resolution, has the potential to restructure the functionalities of a classic dispute resolution mechanism. To decipher this complex integration of blockchain with smart contracts and arbitration, it, therefore, becomes necessary to understand the underlying intricacies of these concepts.

One of the greatest ever technological inventions gifted to humankind, in the field of finance merged with technology, is the blockchain. The true genesis of blockchain technology dates back to the year 1991, when two cryptographers Stuart Haber and Scott Stornetta, originally conceptualised the idea and mathematics behind the crux of the technology. In 2012, a group of anonymous coders under the pseudonym of Satoshi Nakamoto implemented the first-ever version of the blockchain technology, based solely on the work of Stuart Haber and Scott Stornetta. Blockchain, also known as the time-stamping server or the Distributed Ledger System (DLS), operates by time-stamping the hash of a block. The time-stamp can be used as proof to show that the data must have existed at that particular time. Each block contains the data of the previous block, in its hash, thereby forming a chain. The hash algorithm protects the data or value, inside a block, from being replicated, thus making the block impenetrable. With this amazing feature, blockchain technology can also be used by law firms to store evidence and records in digital versions. By connecting this database with a cloud network, legal prosecutors can access them from anywhere in the world. To work through a cloud platform, lawyers can use legal practice management software or parallel solutions to retrieve the evidence along with managing their clients through it. Blockchain technology would make it tough for cybercriminals to hamper those proofs. Blockchain technology, because of its transparent nature, acts as a global spreadsheet that can be downloaded on any system, anywhere, and by anybody. Within a few years after the hypothesis of blockchain was put forth, an American cryptographer, and law graduate, Nick Szabo, theorised the concept of smart contracts, keeping in mind the blockchain technology. Smart contracts, in plain terms, are construed as digitised contracts, which can efficiently automate the implementation and execution of a contract, and every other element related to a contract. For instance, smart contracts with the help of blockchain technology can aid in the creation of data-driven logic that could help investors to use their real estate assets in unique ways. This in turn can enable blockchain and real estate to be closely associated with each other. Such implementation can also help the investors in even gaining exposure to the real estate market without actually holding the underlying assets.

The innovative approach of the European Union (EU) towards defining technology makes it a global leader in tech-based policymaking. Furthermore, the establishment of a blockchain observatory by the European Commission, provides an insight into the development of a regulatory model for smart contracts and blockchain, making it significantly relevant to the contemporary jurisprudence on the blockchain.

The legal status of smart contracts in the EU

An increase in digitisation of transactions introduced the concept of E-contracts, which is rapidly replacing traditional written contracts. The term E-Contracts, though not explicitly defined in the Electronic Commerce Directive (ECD), has been enunciated, under Article 9, as a contract which may be entered into, by the parties, through an “electronic means”. Additionally, under the said provision, E-contracts are to be given legal effect throughout the Member States. Similarly, concerns relating to signatures in an E-contract are guided by the Electronic Signatures Directive (ESD). Smart contracts, which are a series of electronic records that are securely stored by parties with the help of blockchain, can be interpreted under the purview of “electronic means”. Although this can be considered as an alternative interpretation, EU countries have not legally recognised smart contracts. However, in 2019, Italy brought in a law to provide formal recognition for blockchain-based smart contracts as a part of DLS.

Blockchain Arbitration – The future is now

Around two decades back, people thought the use of digital currencies for transaction purposes would be practically impossible, and yet here we are. In this fast-moving world, automation seems to take the lead. We now have applications (like Coin Cloud, for example) and secure websites that can help with digital currency transactions. Blockchain arbitration, with the help of smart contracts, can facilitate the functions of; storing and verification of rules, and automated execution, upon the setting-off of the smart arbitration clause incorporated in the smart contract. The block arbitration can be bifurcated into “on-chain” and “off-chain”. While “on-chain” involves the use of a smart contract in a classic dispute resolution mechanism, the term “off-chain” means arbitration without the use of excessive automation, except for the purposes of appointing an arbitrator.

In case of a dispute, the smart contract will notify the jurors, who, after the analysis of the documents of evidence, coded into the smart contract, will pass an award befitting the case. In simpler terms, a party can digitise the terms of a contract and lock the funds into a smart contract, and condition the smart contract, in such a way that only if the task at hand is fulfilled, the funds will pass through. After this process, the self-executable nature of the smart contract will automatically enforce the award and transfer the prescribed fee to the jurors. Though this concept seems to be relatively new, an open-source online dispute resolution protocol named “Kleros” is already at the forefront. Kleros uses crowd-sourced jurors to consider the evidence and settle the dispute.

Examining the issues and challenges in blockchain arbitration

The functioning of blockchain arbitration highlights various concerns. For instance, in an on-chain arbitration, due to the submission of coded evidence, there would be no requirement of oral hearings, which is an integral part of the arbitration proceedings. This modernised method of dispute resolution ignores the principles of natural justice and disrupts an integral part of the adjudicatory mechanisms. No matter what the nature of the case is, every person, according to the law, must be subjected to a fair trial, which is possible only if the principles of natural justice are being followed. Furthermore, due to the nature of the strict functionality of blockchain that eliminates the presence of third parties, the possibility of procurement and admission of evidence from third parties is completely ruled out.

An important principle of arbitration is the underlying idea of confidentiality. Despite the strong protection afforded by blockchain, when an independent third party is involved as an oracle in dispute resolution, data privacy can pose as a significant concern. The provisions of the General Data Protection Regulation (GDPR) are not empowered enough to regulate the intricacies in the decentralised functioning of blockchain, which makes it difficult to impose liability on data controllers. Furthermore, the traceable feature of blockchain is again in conflict with the GDPR’s requirement of the ‘right to be forgotten’.

Ultimately, technology can never come without posing any flaws or risks. No matter how hard coders try to maintain perfection in the code, there will always be a point where one error will crumble and disrupt the entire platform.

The hassles in the enforceability of awards

The New York Convention on the Enforcement of Foreign Arbitral Awards of 1958 (hereinafter referred to as ‘the Convention’) is the most prominent code on enforcing international arbitral awards with 166 contracting states to the Convention. According to Article II of the Convention, an arbitration agreement needs to be in ‘writing’ and requires the signature of parties. However, in a virtually operative blockchain arbitration, there is no scope for written agreements or signatures. The UNCITRAL Model Law, 2006, under Article 7, allows for electronic communication in arbitration agreements which includes emails and telegrams that can serve as evidence to the agreement. Although the UN General Assembly in its interpretation of Article II of the Convention stated that the use of telegram or telefax did not signify an exhaustive list and had the potential to include electronic communications, the UNCITRAL’s recommendation to incorporate the provisions of Article 7 within Article II(2) of the Convention has not been accepted till date. Since there is no formal recognition provided to electronic agreements, courts can decide whether to take UNCITRAL’s recommendations into account, considering the varying facts and circumstances of the case.

The way forward

Alternative Dispute Resolution (ADR) mechanisms were introduced to speed up the delivery of justice, with arbitration being the most opted form of ADR. Until a few years back, it was considered to be the fastest mode of justice delivery, but now something even faster has been theorised and put to use by some of the most prominent open-source websites. The most beguiling feature of arbitration is its ability to adapt to innovations and changes as opposed to rigid traditional court litigation. However, various domestic laws in the EU are not equipped, at this stage, to deal with the issues arising out of such arbitrations. The basis of contract formation needs to include within its purview ‘codes’ as an acceptable form along with written and oral agreements.

Similarly, the Convention should be flexible to allow for electronic-based arbitration agreements in line with the 2006 UNCITRAL recommendations. The issues with data privacy can be handled by using a private, permissioned, blockchain server, in which the transactions are within a closed circle and cannot be accessed by an outsider. Nevertheless, technology, in general, must not be used as an all-pervasive entity; rather, it must be used as an assisting mechanism.

Darshan Bhora is a penultimate year student of law at SASTRA University, India, and Aisiri Raj is a third-year student of law at Christ University, India.