Preventing Crypto Disputes: Blockchain’s Legal Considerations13 January 2023
Blockchain networks allow consumers and businesses alike to enter transactions with each other across the world using cryptoassets, in particular cryptocurrency. Many of these transactions present numerous advantages over their traditional counterparts, such as:
- Decentralisation – because of blockchain’s peer-to-peer structure, transactions can be executed, documented and registered without the need for any centralised authority. Having multiple copies of the ledger across numerous computers provides robustness and reliability.
- Immutability – once blockchain transactions become validated on the network, the chain of data is assembled and becomes irreversible. Though all permitted users on the blockchain have access to the transaction database, this data cannot be reversed or amended, meaning entries are permanently recorded. One of blockchain’s main selling points is that any logs created on the network are stable and unchangeable.
- Anonymity – blockchain‘s private key encryption allows for anonymous and pseudonymous exchanges. While apt for ensuring the security and integrity of data, this encryption allows for unique user identity verification.
Despite these advantages, parties can still find themselves in disagreement with one another and disputes may arise. Parties must take in account the following key considerations under which a crypto dispute may arise:
- Formation of a contract
- Parties (involved and obligated under the contract)
- Applicable law and competent jurisdiction
- Consumer protection
Key Considerations in a Crypto Dispute
Formation of a contract
In smart contracts, as with traditional contracts, parties agree to provide something to each other (e.g. services in exchange for payment or some other consideration). The key difference is that smart contracts are digitally and automatically executed. The automation and digitalisation of contracts creates uncertainty as to: (i) whether the parties intended to enter into the contract or entered the contract with their knowledge; (ii) whether the formal requirements of the contract were met; and (iii) if not, whether the contract is void or voidable.
It should be noted that different jurisdictions impose different formal requirements to make a contract legally entered and valid. For example, the transfer of real estate ownership in Bulgaria must be in the form of a notary deed. Therefore, for certain types of contracts where formal requirements must be met, smart contracts may not be sufficient to complete execution requirements. Consequently, a dispute may arise in regards to the formation and validity of the contract.
Blockchain’s anonymous nature means that it may be difficult to identify precisely who the parties under the contract are, and, respectively, who is liable. Individuals conducting transactions online should consider expressly identifying the parties liable under the contract or at least clarify potential parties which may be held liable (where the identity of the parties under the contract cannot be established). This said, liability may arise from issues other than whether the contract’s obligations have been performed.
Given that smart contracts can be executed without a physical meeting, the potential for fraud or misrepresentation is high. The risk of misstatement is compounded by the prevalence of pseudonymous users on blockchain networks. Cryptoassets’ illicit associations might extend to parties fraudulently or negligently being enticed into a contract by misrepresentation.
Applicable law and competent jurisdiction
Since the blockchain has no physical location, questions as to both jurisdiction to host the crypto dispute and the applicable law governing the dispute can arise. Blockchain facilitates contracts between parties around the world, and its transactions often require a network consensus spanning multiple jurisdictions and countries. The network is decentralised, meaning that people can deal directly with one another rather than transacting through a centralised exchange or authority. As a result, blockchain networks are typically outside of the control of governments or central authorities, such as credit and financial institutions, and are therefore not subject to their rules.
The interpretation of traditional international contracts varies significantly between jurisdictions. This applies equally to smart contracts. In order to resolve a dispute and determine a claim’s merit, parties first look to any governing law and dispute jurisdiction stipulated in the contract. If these have not been clarified in advance, it is crucial for parties to figure out where the contract has been entered and where its obligations are to be or have been performed, to be able to identify the right forum and governing law for the dispute. Identifying the latter is crucial for a crypto dispute given the differing approaches each jurisdiction takes towards governing cryptoassets, which are still in their relative infancy.
As the crypto market grows, new businesses such as exchange platforms will gain prominence providing important online services to customers around the world. Once successful businesses grow their reach and improve their market position, they will often try to exclude liability in their customer agreements. In particular, they may transact on the basis of very favourable standardised contracts as well as terms and conditions loaded with clauses written to protect them from risk and expose the customer to the potential downsides of the transaction. In such situations, where the weaker party may bear the brunt of both legal and commercial risk, consumer protection law plays a crucial part in order to keep things fair and balanced.
Individuals benefit from consumer protection law if they are not engaging in commercial activities, eg, buying and reselling cryptoassets on a professional or regular basis. While consumer law protections vary in different jurisdictions, within the European Union consumers are usually entitled to the following:
- Being informed of the quality, quantity, potency, purity, standard and price of goods and services. The consumer’s understanding of the contract may not be the same as that of an experienced trader, and, therefore, businesses must draft their contract documentation sufficiently clearly to consumers.
- Having access to a variety of goods or services at competitive prices.
- Being able to seek redress against unfair or restrictive trade practices.
Meanwhile, if a person is engaged in a trade or business related to cryptoassets on a regular and/or professional basis, they may be treated by the law as a trader or professional investor. This means they will be deemed to possess the experience, knowledge and expertise to make their own investment decisions and properly assess any risks related to such decisions. Professional investors do not benefit from consumer law protections.
Blockchain is decentralised and can facilitate contracts between parties across the world. Although parties may reach their own consensus about how to settle a dispute, enforcing judgement after a crypto dispute comes with significant hurdles where the blockchain network is permission-less and open-access.
With a traditional contract, the disputes will be resolved by the relevant jurisdiction and its courts. However, determining a smart contract’s jurisdiction is not a given, and practical difficulties follow in terms of the steps that can be taken to preserve cryptoassets. Significant investigation will be required to obtain information in respect of another litigant. There is some scope to ensure that awards can be made if a claimant succeeds. Certain details such as a user’s wallet key may be available, and there may be circumstances where third parties can retain some control over a user’s currency. Notwithstanding this, the pseudonymity attached to cryptoassets and smart contracts ultimately makes it difficult to enforce contract terms or awards as is currently done for traditional contracts.
Ownership of cryptoassets may be hard to establish, especially if the assets have been purchased via a crypto exchange platform. Most of the exchange platforms use corporate vehicles around the world to hold the cryptoassets of their customers in trust. This may lead to situations where the beneficial owner or the trustee is unknown, or where it has been decided to transfer the entrusted cryptoassets to third parties. Tracing ownership is particularly relevant where the cryptoassets held have risen in value. If the beneficial owner chooses to assert a proprietary claim (i.e. assert their ownership over the asset or its traceable proceeds) the assets they receive may end up being more valuable than what they paid under the contract. If there is a breach of trust, regular difficulties in tracing the transferred cryptoassets are compounded by blockchain’s anonymity. Holding the crypto exchange platform or the trustee liable may not always be an ideal solution given the problems with enforcing judgements in blockchain’s decentralised network.
When it comes to blockchain transactions, parties must carefully consider the contract they are entering into, and consult experienced advisers in order to prevent uncertainty or ambiguity at an early stage.
NBLO’s lawyers are well established and experienced in crypto matters. We often advise on crypto dispute and different types of blockchain transactions, particularly transactions related to cryptocurrencies, NFTs, ICOs and other relevant matters. For more information, please contact us via our website form or at [email protected].