A student-run group at NALSAR University of Law
[This post has been authored by Harinie. S, a fourth-year law student at Symbiosis Law School, Hyderabad]
The recent onset of economic recession highlights the need to overhaul the governance system of the largest player of the economy- the banks. The failure of Lakshmi Vilas Bank and Yes Bank, and the downfall of Dhanalakxmi bank’s management are a result of a bad corporate governance system. The same has been acknowledged by the Reserve Bank of India (‘RBI’).
[Prakarsh and Shruti Mishra are third year students enrolled at the National Law Institute University, Bhopal.]
Any discussion on the issue of blockchain arbitration must begin with an understanding of the technology involved. Blockchain technology is not as new as it is perceived to be. The whitepaper released under the pseudonym of Satoshi Nakamoto brought this technology to fore, originally designed as a public ledger, more than a decade ago in 2008. This technology ever since its inception has rapidly been utilised for several other applications ranging from healthcare, blockchain governance, to even blockchain music.
[This post has been authored by Sindhu A., a final year student at School of Law, Christ University.]
In terms of organ donation, India is ranked among the lowest globally, with an organ donation rate of a mere 0.86 donors per million. According to a recent study, around 5,00,000 people need organ transplantation every year and 90 percent of the people on the waiting list die without receiving an organ. India was known as the most common source of organ trade and although there was a gradual decline with the enactment of legislations, the illegal underground market persists as a looming threat. The above-mentioned statistics indicate the need for a fundamental change in the way the Indian organ network operates. One of the most efficient ways to remedy this is to appropriate blockchain technology to better manage organ donation and allocation.
[This post has been authored by Ujjawal Bhargava, a fourth-year student at the Institute of Law, Nirma University, Ahmedabad.]
Copyright is a right provided to the creators of literary, artistic, dramatic and musical works as well as to the producers of sound recordings and cinematographic films. The rights of the creators include inter alia, right of reproduction, adaptation, and translation of work and communication to the public. However, despite the bundle of rights to provided to the authors, they are infrequently utilized even their copyright is infringed. The reasons for the this include lack of transparency about the legal status of copyrighted work, lack of knowledge about the right owner and piracy, etc. The status quo can be appropriately described “like having the keys and title to your car, but not knowing where it’s parked: in theory you own it, however in practice you cannot use it in the intended way.”
[This post has been authored by Sanah Javed, a fourth year student at the School of Law, Christ University.]
Blockchain technology refers to a distributed ledger which helps record the transactions taking place between multiple users over the internet. In a blockchain, there exist multiple blocks of information that rests with the computer base of each user (node), in order for a transaction to be complete. Each node must verify or authenticate the transaction thereby negating the need for a centralised trusted body such as a Bank. Blockchain technology possesses certain key functions such as ‘hash’ and ‘timestamping’ that make it unique. The Hash function helps in validating the integrity of a file. In case of any tampering or difference, the hash will produce an entirely different result hence detecting the tampering. Further, Timestamping provides a chronological record regarding the creation, access and modification of the transaction. These aspects make blockchain an irreversible and incorruptible repository of information, and hence extremely useful form of evidence.
[This is the second part of a two-part article by Muskan Agarwal (National Law Institute University, Bhopal) and Arpita Pandey (National Law Institute University, Bhopal). Part 1 can be found here.]
Previously, the authors looked at the contradictions between blockchain and GDPR with regard to the principal obligations enlisted in GDPR. In this post, the authors will carry out a feasibility assessment of the solutions proposed.
[This is the second part of a two-part article by Muskan Agarwal (National Law Institute University, Bhopal) and Arpita Pandey (National Law Institute University, Bhopal).]
This is the first part of a two-part post that undertakes an analysis of the points of friction present between the fundamentals of blockchain technology and GDPR and of the various solutions that have been proposed to address the inconsistencies.
In a previous post, the concept of smart contracts as used in the legal field was explained comprehensively. Smart contracts are pieces of software that are formed when certain operational terms of a contract are written in the form of electronically executable codes. They were originally envisaged by Nick Szabo and theorized in a paper titled ‘Smart Contracts: Building Blocks for Digital Markets’. He used a rudimentary example of a vending machine to explain the concept. A consumer inserts cash into the machine and enters his preference. The machine then automates the execution of the contract and the goods are delivered to the consumer. The introduction of Blockchain technology has added another dimension to this concept and has exponentially increased its application. Self-executing contracts, based on the Blockchain are a reality now, and have found applications in a myriad of fields. An increasing popularity of the Blockhain and its uses has necessitated an overview of the progress made on this front, both, in terms of legal developments as well as feasibility of actual use.
One such innovative, immensely useful, and lucrative application is in the field of derivatives. Explained simply, a derivative contract is one whose value is based on an agreed underlying financial asset or a set of assets. Smart derivative contracts inculcate the advantages of smart legal contracts such as inalterability, self-enforcement and removal of intermediaries, while also providing the flexibility that comes with the written word, necessary for making derivative contracts viable. In September 2018, Bloomberg reported that Morgan Stanley, one of the world’s leading investment banks, would be offering Bitcoin swap trading for clients. CNBC, in a follow up piece, added that Goldman Sachs is working on a derivative for the Bitcoin. These derivatives have been developed on increasing client demand, and have gained traction despite Bitcoin losing a huge chunk of its value in months preceding September 2018.
Smart contracts derive utility from the automated and guaranteed enforcement of promises made ex ante more than anything else. The reduction in enforcement costs has been pegged as their greatest advantage. Researchers have tried to exploit these core advantages and come up with futures, options, and swap models of smart derivative contracts.
The most important work on taking the model comes from the International Swaps and Derivatives Association (“ISDA”). In a whitepaper published in October 2018, ISDA has developed the concept of a derivative smart contract and laid down a roadmap to their proper construction. In its introduction, the paper lays down that a smart derivative contract lies at the intersection between a smart legal contract, which in itself is a subset of a smart contract, and a derivative contract. The explanation appended to the Venn diagram reads as follows:
“Smart derivatives contracts are smart because they are derivatives contracts with some terms that can be automatically performed. Those terms are expressed in a form that enables their efficient automation. Other terms that are not automatically performed are expressed in natural language.”
Following this analysis, the paper talks about the actual applications of smart contracts to the derivatives market. Automation, as mentioned above, is the key advantage that smart contracts have to offer. A distinction is made between the parts of a derivative contract that can be automated, and the parts of a derivative contract that should be automated. In addition to highlighting that automating the entire contract is neither possible nor desirable, when viewed from a commercial perspective, it also elaborates on how certain ambiguous legal standards, such as ‘a reasonable person’ ought to be so for the proper functioning of private law. A previous paper from ISDA, elaborates on what operational clauses are. Explained simply, they are if-then functions in a derivatives contract. For example, ‘Pay X $100 per share brought on date B if condition Y is met’. These basic Boolean functions are encoded into a smart legal contract and the operational part of a derivative contract is automated.
The natural language of the contract, however, needs to be retained for certain non-operational parts of a derivative contract. Provisions such as the governing law of the contract, arbitration clause, a clause imposing a duty of best efforts on parties, et cetera are non-operational clauses that need the flexibility of the written word. The smart contract can be added as one of the terms to this written contract and integrated in a way that the performance of terms still stands guaranteed. The ISDA has concluded the paper with an effective model for the implementation of such a scenario.
A few other models have come up independently of ISDA. Future or forward options where a smart contract can be programmed to buy or sell security tokens at designated timelines; an options contract where the owner of a security token is given the right but is not burdened with an obligation to sell; a swap model with two different security tokens to hedge against market uncertainties. Their adoption on a commercial scale remains uncertain as of now. While banks and financial institutions have taken steps towards this direction, the solidification of legal frameworks stands in their way.
After an overwhelming response and a positive market reaction, ISDA followed the white paper up with another one titled ‘Legal Guidelines for Smart Derivatives Contracts: Introduction’. In this paper, ISDA has evolved four principles for the development of smart derivatives contracts. The first principle lays down that the smart contract framework needs to meet the existing legal and regulatory framework. While it says that the smart derivative contracts must comply with both, the standards governing smart contracts, and the standard governing derivative contracts, Indian jurisprudence has not developed on the functioning of smart contracts. Any smart legal contract, thus, need only satisfy the provisions of the Indian Contract Act, 1872. The second principle develops on the notion that only the part of the derivatives contract that is capable of being automated should be considered. This commonsensical principle does not need much further elaboration.
The third principle points out that effective automation should be based on legal validation. That is to say, lawyers and legal enforcement officers should be able to validate the legal effect of any coded or automated provision. The legal effect of the code must align with the intended legal effect of the contract. The mere fact of automation must not discount the nature and purpose of the contract. Lastly, leaning more on an economic point of view, the benefit of automation must outweigh the cost of such automation. This principle adds a cost benefit analysis to the feasibility of smart contracts and touches the core of their utility.
The derivatives market in India is still relatively new and undergoes change and development on a regular basis. Markets and technological operations have received the introduction of Blockchain and smart contracts positively. It has huge potential to alter how we think of the derivatives market. ISDA has taken the lead in venturing into tapping the potential that these technologies have in store for us. The whitepapers and other literature need further development and research, and this paper has sought to consolidate the existing works for better understanding in Indian context. No legal machinery or regulatory framework exists at this moment to make the fusion of smart legal contracts and derivative contracts a solid possibility. Until initiative is taken and more research is done in this area, India could fall behind the international trends in fully embracing this advancement. It is urged that foresight be exercised in attempting to make India friendly to such developments. The author sees this piece as a small step towards ensuring the same.
The Ministry of Economic Affairs in its recent press release dated July 22, 2019, prepared a report on the Committee on Virtual Currencies, which proposed a ban on the so-called “private cryptocurrencies”.
The Government of India had constituted an Inter-Ministerial Committee (IMC) on November 2, 2017 under the Chairmanship of Shubash Chandra Garg (Secretary, Department of Economic Affairs) in order to study the issues related to virtual currencies and propose specific action to be taken in this matter. The committee recommended that all private cryptocurrency like Bitcoins should be banned due to the volatile nature of their price. Additionally, a fine of INR 25 Crore may be levied and imprisonment of up to 10 years may be awarded for carrying on activities associated with cryptocurrencies in India.
The report garnered a lot of negative attention, with the crypto community taking the view that it was extremely backward looking and had a regressive approach to such a futuristic concept. In order to recognize the impact of the announcement, it is necessary to first understand what virtual currency is.
A virtual currency is a digital representation of value that can be digitally traded and functions as (a) a medium of exchange, and/or (b) a unit of account, and/or (c) a store of value, but does not have legal tender status. A virtual currency is a private medium of exchange that does not in any way reflect a sovereign guarantee of the value or legal tender status. Virtual currency is therefore distinguished from the FIAT currency of a country that is designated as its legal tender. Cryptocurrencies are a subset of virtual currencies that is decentralized and protected by cryptography. Bitcoin is an example of a cryptographic virtual currency, and was the first of its kind.
Currently, the term “legal tender” finds expression under Section 26 of the RBI Act, which states that, “every bank note shall be legal tender at any place in India in payment or on account for the amount expressed therein, and shall be guaranteed by the Central Government”. The main point of difference between fiat currency and virtual currency is that while the former is expressly guaranteed by the Central Government, the latter does not provide for the same. In order for any virtual currency to be declared as legal tender, it would need to be expressly guaranteed by the Central Government. Only in that scenario would the parties be legally bound to accept it as a mode of payment.
In the third chapter of the report committed projected the idea of Central Bank Digital Currency (CBDC) that shall be the “Digital Rupee” to be the sole cryptocurrency in India having the following key attributes-
Having discussed the above, the Committee appreciated the regulatory concerns associated with virtual currencies. The topics relating to Distributed Ledger Technology (‘DLT’) and Blockchain were delved into deeply and their complexity duly recognized. DLT refers to technologies that involve the use of independent computers to record, share and synchronize transactions in their respective electronic ledgers. Keeping such distributed ledgers obviates the need for keeping the data centralized as is done in a traditional ledger, which is why DLT is extensively utilized by virtual currencies.
Primarily, a transaction under DLT refers to the transfer of ‘value’ from one to another, which could be a record of ownership of assets— money, security, land titles, etc. — or the record of specific information such as information about one’s identity or health. Blockchain, on the other hand, refers to a specific kind of DLT which uses codes to encrypt transactions and stack them up in blocks, creating Blockchains.
As mentioned above, the IMC recognizes the potential of DLT and Blockchain and acknowledges that the application of DLT is being explored in the areas of trade finance, mortgage loan applications, digital identity management or KYC requirements, cross-border fund transfers and clearing and settlement systems. To that effect, the Committee advised the Department of Economic Affairs to take necessary measures to facilitate the use of DLT in the entire financial field after identifying its uses, and further suggested that regulators such as RBI, SEBI, IRDA, PFRDA, and IBBI explore the idea of evolving appropriate regulations for development of DLT in their respective areas.
Consequently, the IMC is of the view that it “would be advisable to have an open mind regarding the introduction of an official digital currency in India”. It is pertinent to note that that the RBI Act has the enabling provisions to permit the central government to approve a “Central Bank Digital Currency” (CBDC) as legal tender in India.
While the use of technology in virtual currencies has multiple upsides, it is not without grave risk. The IMC was of the view that private cryptocurrencies lack the necessary attributes of a currency, such as a fixed nominal value that characterizes legal currency.
Another concern plaguing the committee is that non-official virtual currencies can be used to defraud consumers, particularly unsophisticated consumers or investors. The IMC gives the example of the Rs. 2,000 crore scam involving GainBitcoin in India where investors were duped by a Ponzi scheme. In addition to the above, it has been observed that certain volatility exists when dealing with such currencies. In a country where lakhs of traders get involved in such currencies, this could have huge implications. Secondly, the IMC is worried that if private cryptocurrencies are allowed to function as legal tender, the RBI would lose control over monetary policy and financial stability, as it would not be able to keep a tab on the money supply in the economy.
Also, the anonymity of private digital currencies poses a risk to law enforcement, due to the potential for its use in illegal activities such as money laundering and terrorist financing activities. The lack of grievance redressal mechanisms is another major issue, due to the irreversible nature of such transactions.
The IMC report promulgates that the government should consider an official digital currency in lieu of private virtual currencies or crypto coins and tokens. On the other hand, the committee notes the risks involved and volatility in the prices of private cryptocurrencies, which inevitably led to them recommending a ban on cryptocurrencies in India and imposing fines and penalties for carrying on of any activities connected with cryptocurrencies.
This has been subjected to backlash from private traders who have sharply criticized Section 2.7 of the Recommendations which states that “the Committee notes with serious concern mushrooming of cryptocurrencies almost invariably issued abroad and numerous people in India investing in these cryptocurrencies. All these cryptocurrencies have been created by non-sovereigns and are in this sense entirely private enterprises.”
The IMC has opined that these crypto-assets are not backed by any intrinsic value, which have not been recognized as a legal tender in any jurisdiction, but that’s not entirely true. Many cryptocurrencies, these days, are backed by petroleum, gold, as well as the US dollar in the case of Facebook’s Libra. The IMC does not make any differentiation among cryptocurrencies that are not backed by any central banks. The report presents energy consumption as an issue in the context of Bitcoin mining, however, the report does not delve into the numerous solutions suggested world over to curb this consumption. Cryptocurrencies have never been used as a legal tender or currency in India, nor was it the expectation of any crypto startup. It has always been traded as an asset, which is now being banned.
In reference to the same, the panel has asked the government to consider the launch of an official government-backed digital currency in India, to function like banknotes, through the Reserve Bank of India. Authorities in various countries are considering how to regulate cryptocurrencies, particularly after Facebook announced plans to launch one called Libra, because of risks to the financial system and consumer data. According to recent reports, Libra will not be launched in India due to the current Indian regulation of not endorsing private cryptocurrencies. While Libra is likely to have a massive impact on global e-commerce, it is in the money transfer space where it could be a potential game-changer.
Aside from an extremely brief inspection of the application of DLT in India, the report also includes the proposed bill banning crypto assets that will be presented to the Supreme Court as well. It remains to be seen whether the Supreme Court accepts or rejects the same in toto or comes up with their own guidelines on the issue.
Smart contracts are a set of self-propelled contracts which use blockchain as a platform to complete the transactions. This concept was introduced by Nick Szabo back in 1996. Since then, a lot of nations have endorsed this concept for being a technological revolution. In this post, I will endeavour to show that smart contracts are not really a smart option as they are riddled with several unsolvable legal issues. The analysis is primarily focussed on the smart contracts made on ethereum blockchain.
Smart contracts are made on a platform called Solidity. To execute a contract, you need to pay transaction fees to a miner so that he can mine a block for your contract. The technical jargon for this transaction fees is Gas, which is bought by paying a digital currency called Ether.
This can be understood with the help of an analogy. Imagine you are in the food court of any mall which requires you to purchase a food court card. You go to the counter and pay a certain amount, which gets credited to your food court card. This amount can then be used to purchase a big cheesy burger for instance. In the smart contract universe, the counter is the blockchain, the amount paid is the Ether coins, the credit in the card is the Gas, the burger shop is the miner and the big cheesy burger is the execution of your smart contract.
Now imagine that the burger shop owner is slightly eccentric. Apart from the type of the burger, he varies his prices depending upon the number of customers his shop has. Also imagine that he is a greedy man, who first serves those who are willing to pay more. This is the case with the miner and the gas prices. The prices of Gas depend on the market and can fluctuate greatly. There have been multiple instances of increase in gas prices due to an increase in the number of users. The gas price also depends on the nature of your contract and the kind of computer programming you choose. Also, like the greedy burger shop owner, the miners execute the contracts based on the gas fees paid. The more gas you pay, the more incentivised the miner is to execute your contract before any other contract.
Hence, if the users of smart contracts increase in the near future, the miners will increase their price in all probability. Since the very execution of smart contract depends on the miners, this will increase the overall cost of executing the smart contract considerably. As soon as this happens, smart contract technology will become inaccessible to a lot of Indians. Currently, there are only 5,00,000 users of smart contracts but still, the simplest of the smart contract is of worth $7000. With the increase in the number of users, this price will go up considerably and would remain affordable to less than 1% of Indians. Therefore, if this technology is allowed to become popular without regulating the gas prices, it is bound to be a catalyst for a plutocratic economy. But then, the important question is that can the gas prices be regulated?
Regulation of gas prices is next to impossible. The concept of smart contracts uses a decentralised technology in which the servers are distributed globally. Hence, no country can put a price ceiling on the gas single-handedly. For the sake of argument, even if a governmental agency manages to regulate the prices within its country, the user can always resort to offshore platforms to nullify the regulations. To counter this, having a uniform regulation at international level is highly unlikely since the developed countries would have all the incentive to keep the prices unregulated and give their citizens the priority in executing the contracts over the citizens of other counties. In a press conference last year, RBI did show apprehensions regarding non-uniformity in international regulations of cryptocurrencies and said that it can disturb the whole economic balance of the country.
This is further complicated by the fact that the identities in the smart contracts remain anonymous. Most of the blocks do not have the name or identity of the miner and this identity cannot be traced even by the cognoscenti of blockchain technology. Therefore, even if the international community builds consensus on the price ceiling of the gas, locating and punishing the offender is next to impossible.
Though the Supreme Court is still in the process to gauge the possibility of regulating cryptocurrencies,[1] the aforementioned analysis shows that the regulation of at least gas prices is not possible. Hence it can be said that if smart contracts become popular in India, they are likely to increase the divide between rich and poor if nothing else.
One of the myths regarding smart contracts is that they are completely self-executing and can be directed to execute the transactions in a particular time frame. Though the contracts work on ‘If-Then’ logic, a timer cannot be set in these contracts. This is the inherent fault of proof-of-work blockchain (on which the smart contracts are based) because the transactions can arrive on different nodes at different times. For executing a smart contract on time, one needs the help of external service providers called ‘Oracles’. But there always remains a problem of trusting the oracles as they can easily misbehave and procrastinate. Therefore, it is highly probable that there occurs a delay in the execution of a smart contract. This probability will further increase in the future if the users of smart contract increase at a rate faster than Oracles, so as to create more workload for them.
A pertinent legal question which can be raised now is regarding the contracts for which time is of the essence. This is a kind of contract which the parties agree to abide by before a stipulated time. As per the Indian Contract Act, if any of the parties fail to comply with the time requirements, the contract becomes voidable at the option of the other party.
Now let’s imagine that the parties enter into a smart contract of which time is the essence. But because of the oracle, the execution of the smart contract gets delayed. The only option which the aggrieved party now has is to externally give the command to kill this contract. But since there is a risk that the contract can execute itself anytime, the aggrieved party needs to exercise this command immediately after the stipulated time is over. On that account, the problem arises in cases where the end of this stipulated time is ambiguous and was not fixed explicitly by the parties beforehand. In such cases, there may be legal complications as to whether time was of essence or not and what was the specific point at which the contract was to be executed. Therefore, the party exercising this command in such a scenario is unduly burdened with the risk of giving the command unjustifiably and bear the brunt of repaying the huge losses to the other party.
The problem does not end here. Even after assuming this extra burden, the option of making the contract void is still jeopardised in this technology. One, even after giving this command, the contract can still execute itself and can make you pay Ether unreasonably. Second, there is no guarantee that even after giving this command your money will be returned to you. In a very famous fiasco, one user lost $300 million when he gave this command. Hence, it can be concluded reasonably that it will be a nightmare for the parties if they choose smart contracts for building a contract where time is the essence.
On the account of arguments made in this post, it can be said that smart contracts do not seem to be a feasible option. This is especially true for developing countries like India, where people can’t afford the exorbitant gas prices and where people are still not aware of legal intricacies involving the essence of time in a contract. There is, therefore, a need for a sustained, nuanced and interdisciplinary study of the concept of smart contracts before adopting it into the marketplace.
[1] The matter is listed as Siddharth Dalmia v. UOI (Civil WP No. 1071 of 2017) for which, the Supreme Court’s website shows August 2, 2019 as the next date of hearing. (Last checked July 25, 2019).
