Smartphones. Smart homes. Smart contracts? Is it actually an innovation that can cause programmers to draft our contracts in the future? Are smart contracts that smart that they cannot be breached? Is code able to be law or is it just a desperate try to help lawyers work? I attempt to answer these questions in this blog post.

Digitalization is undoubtedly having a profound impact on the legal profession. There are many areas of legal work that could be seriously affected by digitalization. But the question of whether the role of law can be played by a program of binary codes is far from clear. In the following blog post, I explore this question and illustrate its relevance with a legal example.

“Is code law?”—What is the problem?

Computer code is primarily in the form of source code written by humans in a specific programming language. However, in order for these coded commands to be executed by the computer, or more precisely by its processor, a “translator” program must create an executable file of binary code that is interpretable by the machine. Many say that computer code, which is written and operated as described above, has many of the same attributes as law. This is known in the literature as the “Is code law?” problem, and the basic question is: is code the law of the computer world? Code imposes command-like constraints on computers in a similar way that law imposes on humans, with a complete logic system behind the commands as complementary, auxiliary rules. Such a rule in the cyberspace is, for example, the mechanism of the processor that interprets and executes commands according to a set of rules. This is the common attribute of law and computer code, which can be called “the ability to control.”

Blockchain technology—the solution?

In order to put this theoretical common ground into practice, a technique is needed to ensure the security of code use, a system that plays the role of justice, an enforceability guarantee as the jurisdiction in the case of law. This is where blockchain technology comes in. The blockchain creates a decentralized system in which the data of a transaction between parties are not stored in a central system, nor as copies on the machines of both parties, but is incorporated into a large chain of transactions that are stored on all the devices that have performed similar transactions so far. A major advantage of the system is that a stored transaction cannot be modified or deleted, as this would require modification or deletion on all the devices in the blockchain. This decentralized model can also provide adequate protection against hacker attacks, as it is not possible to “hack” into so many devices at once with current technologies. It is precisely the above features that ensure that an encrypted transaction is properly stored and can be credibly retrieved, its contents returned, and verified at a later stage.

“Code = Law?” and “Blockchain” = “Smart contracts”

But is there a relevant example of this in today’s jurisprudence? In 1996, the American computer scientist, legal scholar, and cryptographer Nick Szabo drew attention to the possibility of new “protocols” such as smart contracts. The law has an unambiguous answer to the word “contract,” as Section 6:58 of Act V of 2013 on the Hungarian Civil Code (hereinafter referred to as HC) states that a contract is the mutual and concordant juridical act of the parties from which the obligation to perform the service and the entitlement to claim the service arises.

The adjective “smart” means that the contract, although dependent on the will of the parties, is not performed by the factual acts of the parties, but in a self-executing manner, upon the occurrence of certain conditions. In legal terms, therefore, it is an obligation subject to suspensive conditions, which provide guarantees for its subsequent performance. In a very simplified example, a classic vending machine can be considered a smart contract, since it dispenses the requested product on the insertion of a certain amount of money and the selection of the right drink, thus creating a contract of sale between the parties and executing it at that moment. So ideally, it should not be the case that the vending machine gives you a free drink, but neither that it gives you nothing for your money, as the automatic operation assures the parties that the desired contract will be created and performed if the conditions are met. To give a further, slightly more modern and computerized example, a contract for the sale of real estate would look like a smart contract, once the computer detects the payment of the purchase price in the seller’s account, it sends the application for registration of the change of ownership to the land registry automatically, without any further human intervention.

Conditions of smart contracts

There are, of course, several conditions that apply to smart contracts. The most important one is to make the subject of the contract available to the computer. In the example above, it should therefore have access to the seller’s bank account, be able to monitor the amounts received, and be able to identify the person issuing the payment order. It is important that both the seller’s and the buyer’s computers must be capable of filling in an online application form and sending it to the land registry. Artificial intelligence can play an important role in this, where appropriate. In the latter example, for example, an online public administration system is essential (as in Estonia), but the availability and feasibility of such a system is not the subject of this blog post. The contract concluded above is integrated as a block in the decentralized organization of the blockchain. This eliminates most of the foreseeable breaches of contract, since after a purchase price has been paid, the buyer does not have to reckon with the possibility that the seller does not give the appropriate permission for the registration, since the smart contract concluded automatically makes it available. The contract is incorporated into the blockchain system as an unalterable, indelible transaction, which means that if a court case were to take place, evidence could not be manipulated.

Is a written contract a smart contract?

An important requirement for smart contracts within the blockchain system is that the parties must have some kind of unique identifier, a digital signature. This condition, as well as the characteristics of the blockchain system, suggests that smart contracts can be written legal declarations, as they can comply with the technology-neutral written form of the HCC. The content of the contract is clearly expressed in the code and the subject matter of the contract must be accessible to the computer as described above. The declarants can be identified by their digital identifier, even their IP address, and the time of making the declaration is at the time of uploading or connection to the blockchain system, which, as I have mentioned several times, is irrevocable. Based on all this, my hypothesis is that, if the technique of concluding smart contracts becomes widespread and certain disputes are brought before the courts, the court may without further ado find that smart contracts comply with the technology-neutral concept of literality, and that it is possible to make the kind of clauses that the HCC requires for such a form of contract. 

The drawbacks of smart contracts

Of course, in addition to the numerous advantages of smart contracts, there are also disadvantages of this legal technology. The fact that the law can be transposed into computer code with similar coordinating capabilities is only partially true. Certain concepts of civil law, such as the overriding public interest, or private interest deserving special consideration, or, as Zsolt Ződi writes, human dignity, or for example, good cause, are not suitable for being translated into binary code in the computer world, since their very essence, the relation to the situation, the right to discretion as a judge or even as a contracting party, would be eliminated by such a “translation.” In this way, lawyers need not fear that the contracts which form a large part of their work will become a completely programmatic, computer science task, since the specific language and logic of law cannot be entirely molded into a form of zeros and ones. A further counterargument might be the fact that, although code has the regulatory capacity of law, like law, code is written by humans. A poorly written source code of a smart contract can constitute a breach of contract even if it is written by agreement of the parties. For example, if the vending machine mentioned above is programmed not to dispense drinks for every tenth amount dispensed, a breach of contract situation exists that the written program cannot handle because it was taught to handle it, it is its natural way of working. If we look at an example on a larger scale, an airline might, for example, have a smart insurance contract with its passengers so that in the event of a delay or cancellation, a certain amount of compensation is automatically paid to the passengers. In this case, an unpaid amount can mean serious financial damage to passengers.

Summary

The above shows that, to a certain extent, computer code does have the properties of law. It is possible that some of the contracts will be coded as smart contracts in the work of lawyers in the future. However, there are factors that support the need for lawyers to work on smart contracts, and we are therefore talking about a legal technology that, while it can help to eliminate a large proportion of breaches of contract and facilitate the evidentiary process in civil proceedings, will still require important legal input. When and to what extent the use of smart contracts will become widespread is a matter for the future.

Bertalan Máté NAGY is a law student at the Faculty of Law at the Eötvös Lóránd University in Budapest and a scholarship student of the Aurum Foundation. In December 2023, he acquired a certificate at an IT academy for lawyers and gained experience in coding, IT law, and LegalTech. He is a member of the CapsLaw digital law working group of the university that deals with IT law and LegalTech problems.