There has lately been much excitement about blockchain
technology, and one of the chief avenues of optimism concerns its application
to so-called ‘smart contracts.’ Smart contracts are agreements that utilize the
blockchain––a digital ledger, distributed across a network, that securely
records transactions between parties––to automatically and securely execute
obligations when certain conditions are met; for example, a smart contract
might automatically transfer ownership of an item when it is fully paid for,
upon the passage of a set period of time, or upon the meeting of any other
predetermined condition that can be instantiated in computer code. Because they
are based on code, smart contracts can be immediately and automatically
effectuated, without reliance on manual transfer or the intervention of
institutions like courts. Smart contracts have recently been heralded as
potentially transformative legal instruments that can do away with problematic
ambiguity and expensive enforcement.
Like other blockchain-based technologies, the smart contract
is designed to function without reliance on a centralized authority. In
financial applications of blockchain technology (like cryptocurrency), the
institution obviated is the system of state-issued currency and centralized
banking infrastructures; smart contracts are designed to self-enforce without
recourse to courts. In this sense, the smart contract can be understood
alongside a number of other emergent technologies that aim to automate the
enforcement of law —a vein that, read broadly, includes such seemingly
disparate tools as digital rights management systems and traffic ticketing
cameras. These systems are frequently received with much fanfare by
policymakers, and heralded as a way to make the application of legal rules and
agreements more consistent and efficient.
Though smart contracts may serve these goals in some
contexts, I suggest that we should temper our enthusiasm about the
transformation of modern contracting practice. This is because smart contract
boosters tend to understand contracts chiefly as technical artefacts, rather
than as social resources. Under this view, contractual agreements are bare
transactions that can, and should, be optimized through code; term ambiguity
and enforcement costs are understood as inefficiencies that plague the system
of exchange. Understanding contracting practices within broader social and
relational contexts, by contrast, reveals that contracts are in fact much more
than this: they ‘work’ in many ways and accomplish many aims that are
unaccounted for by the smart contract framework.
Blockchain-based Contracts and the Promise of Code-based Enforcement
What makes a smart contract ‘smart’? The underlying
technology enabling smart contracts is the blockchain, a database distributed
across multiple computers. When transactions occur, records of them are
aggregated into blocks of code that are appended onto the chain (the ledger of
transactions). The chief benefit of this structure—which is public, and which
uses sophisticated cryptography to ensure the security and trustworthiness of
the record—is that it removes the need for a centralized authority to
facilitate or mediate the transaction in any way.
Smart contracts are, to many, the most promising application
of blockchain infrastructure. The core idea is this: contracting parties agree
to a set of terms that are instantiated in computer code (and which, therefore,
can include any conditions which are legible to computers). When those
conditions are met, transfers can be made automatically. Some of the real power
of this model comes from the increasing digital interconnection of ‘smart’
devices–– imagine, for example, that a smart lock on your home could effectuate
a short-term rental agreement (and then automatically lock the tenant out at
the end of the lease term), or that payment for goods would transfer
immediately upon arrival of those goods at a particular warehouse within a
given timeframe, detectable by location-tracking technologies. In a sense,
smart contracts aim to collapse contract formation and enforcement into a
single instrument.
This stands in contrast to the way traditional contracts are
enforced. Typically, contract terms are written, acceded to, and—if need
be—enforced, in distinct phases: if a contract is breached, the wronged party
must take action to recognize and document a harm, establish the other party’s
responsibility for the harm, (perhaps) initiate a legal proceeding through
which to establish the breach, and ensure that any damages are paid.
Importantly, the enforcement phase formally depends on centralized
institutions—courts—to intermediate disputes, and on a plaintiff taking affirmative
steps that require access to multiple kinds of resources, including knowledge,
money, and time. Traditional contract enforcement is messy and
resource-intensive—and it is this perceived inefficiency that motivates much of
the excitement about smart contracts.
To be sure, some of this enthusiasm is well placed. There
are good reasons to avoid reliance on centralized authorities for governance:
an authority may be corrupt; it may impose undue delay or bureaucratic
inefficiency in resolving a conflict; it may fail altogether. And goals of
social justice, equality, and fair outcomes may be served by decentralization,
as well. A self-executing agreement could, in theory, obviate some
institutional barriers that keep poor people from being able to make property
claims. Well-resourced institutional players consistently obtain better
outcomes in court than smaller players do, often as a result of procedural
rules and institutional structures. By distributing enforcement outside court
systems, smart contracts might, in some contexts, be seen as removing some of
the barriers that keep the disadvantaged from attaining their legal due.
However, scholars have raised salient critiques of the idea
that smart contracts might transform the current legal regime around contractual
enforcement (that is, of legal-institution-backed ‘dumb’ contracts). James
Grimmelmann and Arvind Narayanan suggest that blockchain boosterism might be
tempered by fuller consideration of the human side of business dealings. What
if you lose your blockchain private key (a secret code which authenticates your
ownership of resources on the blockchain) in a fire? What if you buy a
defective product, and need to show your ownership to invoke state consumer
protection? These sorts of inevitable ‘hiccups’ are poor fits for
blockchain-based enforcement, without the attendant state institutions that
step in in cases of exception.
In addition, there are a number of questions about how smart
contracts will deal technically with issues that are fundamental to contract
law, but which are difficult to instantiate in code: issues dealing with
temporality (such as mutual mistake or recission), or standards that apply to
contracts and contractors across the board, even if not represented on the face
of the document (such as the duty of good faith). These issues represent
important challenges to the smart contract framework, and there are some extant
efforts to address them technically and legally. But I contrast my present
inquiry from these concerns, which have largely to do with translation and
implementation of existing legal standards to a new technological form. I also
bracket from my analysis critiques of the fundamental viability of blockchain
infrastructure—a critique raised most notably in the wake of the theft of
millions of dollars’ worth of cryptocurrency on the Ethereum network, and the
subsequent ‘hard fork’ of the code that resulted, believed by some to indicate
the fundamental nonviability of the model.
My aim here is to raise a separate critique of smart
contracts—one premised on the latent social functions of contracting. Just as
the security of property depends on both technological artefacts and human
institutions in the real world, so do contracts depend on both the technology
of the contract—its form and provisions—and the social behaviours that
surround, support, and sometimes subvert contracting. Smart contract technology
depends on a thin conceptualization of what law does, and how it does it— by
focusing on the technical form of contract, to the exclusion of the social
contexts within which contracts operate, and the complex ways in which people
use them.
How Does Law Work?
Law works through all kinds of avenues other than formal
adjudication. Contracting is a deeply social practice in which parties engage
for all sorts of purposes, and the effects of contract negotiation reverberate
outside of the ‘four corners’ of a formal agreement. In legal studies, the
legal realist perspective has long focused on how law unfolds in in vivo practice, and emphasized that
these practices may diverge significantly from ‘on the books’ agreements. This
perspective suggests that parties engage with legal instruments and
negotiations in order to achieve myriad socially productive aims—including many
that may not be apparent from the face of an agreement. The social context of
law as lived is key for understanding
what law is ‘doing’ in any situation.
People use legal instruments to negotiate their social and
organizational lives in ways that are both complex and counterintuitive. Contractual
obligations are enforced through all kinds of social mechanisms other than the
legal system proper; concomitantly, contracts serve many functions that are not
explicitly legal in nature, or even designed to be formally enforced. This
insight is important for understanding the real-life effects of automated
contracts.
In what follows, I describe three contracting practices in
which people engage to manage their relations. I suggest that each of these
practices, while serving important social aims, are uncontemplated by the
automated enforcement framework underlying so-called ‘smart’ contracts. The
practices I describe (summarized in the table below) are by no means an
exhaustive list, but serve to illustrate how contracting practices operate in
the wild—in ways that belie smart contracts’ assumptions about how contracts ‘work’.
|
Contracting Practice Writing or acceding to unenforceable terms Writing or acceding to purposefully vague terms Wilful nonenforcement of enforceable terms |
Social Aim Set expectations for future behaviour, including behaviour outside Facilitate stable and flexible long-term relations Provide a strategic resource for operating ‘in the shadow of the law’ |
The Behavioural Force of Unenforceability
First, contracting parties may enter into contracts that
contain provisions they know, or suspect, are legally unenforceable. Though
courts generally give parties significant latitude in determining what they may
agree to in a contract, some provisions cannot be enforced for a variety of
reasons, largely based on social policy considerations. Parties cannot, for
instance, legally enforce a contract based on unlawful subject matter, like an
agreement to murder.
More conventionally, contracts often contain clauses that their
authors know to be unenforceably overbroad. This arises commonly, but not
exclusively, in contracts of adhesion (or ‘form contracts’), in which one party
has more or less exclusive ability to specify the terms without negotiation.
For instance, employment contracts frequently contain unenforceable post-employment
non-compete clauses.
Why might sophisticated parties include clauses in their
contracts that they know to be invalid? The most reasonable interpretation as
to why is that the party who chooses to include the clause assumes that the
other party believes it to be valid,
or at least will act as though it is. If I don’t know that a non-compete clause
is unenforceable, I am likely to follow its edicts anyway. In this way,
unenforceable clauses are performative: they ‘work’ functionally, even though
they don’t ‘work’ legally. In a sense, these clauses work because of chilling
effects—because of uncertainty and imperfect knowledge, they deter conduct
beyond that which is actually legally proscribed.
Some unenforceable clauses are included even when the
parties are on a fairly even playing field in terms of resources and knowledge.
In these cases, the inclusion of an unenforceable contract term can serve both
parties’ interests, by operating to influence and communicate norms for each of
their future behaviour. Consider, for example, the inclusion of ‘infidelity
clauses’ in prenuptial and postnuptial agreements, which contractually bind
spouses to a (usually financial) consequence if they cheat; though most courts
refuse to enforce these clauses, they still ‘work’ by communicating
expectations between the parties, and may act to precommit behaviour in a
socially desirable way.
To sum up: parties knowingly include unenforceable terms in
contracts in order to set expectations for one another’s future behaviour—including
behaviour legally beyond the reach of the formal contract. Though this effect
of contracting may serve to intensify power asymmetries in some cases, it might
also be used to prosocial effect, to mutually precommit behaviour, or to
express allegiance to certain norms.
Vagueness and Long-term Relationships
A second set of contracting practices involves the inclusion
of terms that are purposefully vague. Terms might be left uncertain for a
variety of reasons. It might be unduly cumbersome to prespecify terms if the
context of the agreement is likely to shift; parties may have a variety of
motivations for conducting some aspects of their business ‘unofficially’; the
pecuniary or social costs of negotiating terms might be great enough that
parties would rather take a chance, based on their perceptions of costs and
probability of breach, than expend resources delineating terms up front. As a
legal matter, contracts are not enforceable if their material terms are left
vague or open-ended; an ‘agreement to agree,’ though undertaken commonly in
practice, lacks legal weight.
The seminal sociolegal scholarship on this phenomenon is
Stewart Macaulay’s 1963 study about what he termed ‘non-contractual relations’
in business, summarised in my paper. He found that, to a surprising degree, parties
left many aspects of their contractual relationships vaguely planned,
incompletely defined, or imperfectly resolved. This was not for lack of
sophistication; in fact, it seemed to be a deliberately undertaken and
widespread practice in spite of the parties ‘knowing better,’ even when
significant financial risks were on the line.
Why might parties act in such a way? In part, Macaulay’s
businessmen were unworried about the eventual enforceability of a contract in
court because alternative mechanisms, like reputation and internal sanctions,
served in its place. Most significantly, parties may choose not to insist on a
perfect ‘meeting of the minds’ on every term because they anticipate (and hope)
that their relationship will extend beyond the contract at immediate issue. Being
exacting about every aspect of an agreement might endanger the long-term
relationship of the parties. Vagueness, then, preserves operational flexibility
for parties to deal with newly arising circumstances, and sets the stage for
social stability in an ongoing relationship.
This way of understanding contracting behaviour has been
described as a relational theory of
contract. Relationalism pays close attention to the interactions among norms,
practices, and doctrines in transactions, as opposed to a more formalistic,
classical theory of exchange that concentrates principally on legal decision
rules. In this view, contracting is often more like marriage than like bare
one-off exchange; the stability of a relation is more important than preserving
one’s legal rights in each and every situation.
Strategic Non-enforcement and the Shadow of the Law
A third set of contracting behaviours entails parties’
decisions not to pursue enforcement of enforceable agreements. Legal
obligations of all types often go unenforced. Sometimes, parties’ lack of
resources or awareness may limit them from pursuing others’ legal obligations
in court. But, in other cases, failure to pursue a legal remedy serves social
purposes for the non-enforcer, and may be part of a considered behavioural
strategy. A good deal of socio-legal scholarship considers how individuals use
law—and non-enforcement specifically— as a strategic resource for the
management of institutional and interpersonal relationships.
This dynamic is often called ‘bargaining in the shadow of
the law’. The basic premise is that formal enforcement—‘taking someone to court’—is
only one way in which people choose to enforce their legal obligations to one
another, but is often not the best way. In part, this is due to the high costs
of formal adjudication, in terms of both time and money. Even when not formally
used, the spectre of the court has important effects, because it provides a
backdrop and framework against which parties make bargains among themselves. These
self-constructed bargains are often mutually advantageous: they avoid the
‘all-or-nothing’ consequences likely to attend litigation in terms of more
granular, cooperative negotiations. A good deal of socio-legal scholarship
(discussed in more depth in my paper) examines conditions in which such
bargaining is likely to be effective; for instance, it tends to be a greater
resource when strong community norms or networks provide viable alternative
forms of sanction (eg, reputational harms). Enforceable contractual
obligations, rather than operating as steadfast if-then consequences of
noncompliance, create a backdrop of social expectations against which extra-legal
negotiations can occur. Non-enforcement, then, can be as much a ‘use’ of
contract as is enforcement.
Smart Contracts Aren’t So Smart
Contracts are deeply social tools as well as legal ones. We
have demonstrated how contracts operate as social resources, through and
against which people manage their relationships, and within which legal
obligations and social expectations are intricately interwoven and mutually
constitutive.
What are the implications for blockchain-based contracts? I assert
that ‘smart’ contracts fail to take the social complexities of contracting into
account; indeed, they are not designed to. We might think of smart contracts as
book-smart, not street-smart: while they may facilitate technically perfect and
seamless implementation of agreements, they fail to understand or integrate the
social world. The social friction required to negotiate and enforce a ‘dumb’
contract can be highly functional—by preserving flexibility, facilitating
stability, signaling norms, and the like. Blockchain-based contracts rely on
careful prespecification of terms and automated enforcement of obligations.
These contracts thus impose a degree of inflexibility on contractors’ relations
that might short-circuit a number of alternative uses to which law is put.
Smart contract boosterism demonstrates the appeal of bright-line enforcement
rules; rules of this sort often garner strong support from the tech community
due to their computability and perceived efficiency. But when these rules hit
the ground of real practice, custom, and human behaviour, their effects may be
nonobvious or counterintuitive.
Notably, the social effects of contract—which do not require
recourse to courts for enforcement—represent a form of self-execution, as well,
though a different sort than that contemplated by smart contract proponents. We
might think of contracts as sometimes having the capacity to socially self-execute—they ‘work’ via
their effects on parties’ behaviour—rather than through technical self-execution,
in which enforcement relies on code. Social self-execution relies on the
communicative functions contracting serves between parties, which may be wholly
distinct from their formal legal effect.
Of course, this isn’t to say that there is no role for
automated contracts: indeed, they might introduce some desirable social
consequences with respect to equitable access to justice. A good deal of non-enforcement
of contractual obligations results from the high transaction costs of taking
someone to court. To the extent that smart contracts would reduce these
transaction costs, they might beneficially remove an impediment to underresourced
parties’ contractual rights. At the same time, automated enforcement of
contractual obligations—particularly when such obligations are instantiated via
interconnected objects— seems likely to have detrimental effects on
underresourced people, who often depend on transaction costs to grant them a ‘buffer’
within which to operate. Consider, for example, several recent cases in which
subprime lenders have used starter interruptor devices to remotely, and
immediately, disable vehicles whenever a borrower falls behind on payments, to
the great detriment of borrowers.
As a policy matter, we ought to think carefully about the
features of the social setting in which smart contracts are permitted to
operate, the degree to which they might preclude other means of enforcing
obligations, and the social and normative implications of this foreclosure. To
be sure, the subject of the agreement is one consideration here: a stock trade,
for instance, is likely to be a better candidate for smart contracting than
performance of a personal service, due in part to the computational
verifiability of events surrounding the exchange. To realise their promise
while mitigating against their potential disadvantages, ensuing discussion,
development, and regulation of smart contracts ought to attend explicitly to
the relational contexts in which such contracts are deployed.
The foregoing discussion suggests that alternative
enforcement mechanisms might work best when certain social resources are
present in the contracting relationship that can be drawn upon by the parties.
For instance, are the parties likely to want to engage in continued relations
beyond the immediate agreement, suggesting that reputation and stability might
be desirable alternatives to automated enforcement and strict prespecification
of terms? Are the parties motivated to preserve flexibility in their contract,
to account for a changing environment, or to reduce the transaction costs of
meeting an initial agreement? Are they chiefly trying to communicate particular
precommitments or behavioural norms to one another by way of contracting? Do
they trust one another? Are they part of the same community, and if so, how
durable are relationships in that community? Do alternative forms of signaling
(ratings, custom, reputational signals, gossip) exist to incentivize behaviour?
Questions like these will help us to understand the social contexts in which
contracts are likely to ‘work’ in a certain way, and how technological
interventions might operate if deployed there.
Karen Levy is an assistant professor of Information Science at Cornell
University and associated faculty at Cornell Law School.
Karen’s full paper, Book-Smart, Not Street-Smart:
Blockchain-Based Contracts and the Social Workings of Law was published in Engaging Science, Technology and Society.
