Blockchain Technology Related Contracts

Digital coins that can be owned by anyone, spent anywhere, hard to counterfeit, ensuring full transparency, and eliminating all intermediaries. This is the Financial Revolution 4.0. With the unprecedented growth in technology, the banking and financing service industries are undergoing metamorphic transformations. Against this backdrop of massive digitalization of banks and finances, Blockchain technology has established itself as a major player. A peer-to-peer transaction system based on a digital ledger, Blockchain is redefining the architecture of Finance and Banking.

This article seeks to provide a conceptual understanding of this “internet of value,” and Smart Contracts related to it.

There are almost 200 currencies in the world but only one international currency, almost 200 currencies under the control of governments and banks, but only one mathematical currency today, and that is Bitcoin. Cryptographic currency is going to be a part of the future because it has been invented. You cannot un-invent this technology just as you cannot turn the omelet back into eggs.

Andreas M. Antonopoulos, The Internet of Money

Introduction to Blockchain Technology

Most of us have often found our bank transaction hindered by technical issues, hacking of accounts, reaching the transfer limit for the day or high transfer charges imposed by the bank, and the platform used. Cryptocurrency came into existence as the solution to all these problems. Cryptocurrency essentially is a form of virtual or digital currency that runs on a technological platform known as Blockchain Technology.

Blockchain ensures that cryptocurrencies are immune to counterfeiting, and protected by a strong and complex algorithm. In Blockchain technology, for every transaction, a new block is created which comprises of data regarding the amount paid/received and the amount owned by the sender and the receiver. These blocks are linked to each other much like a chain of financial information. This chain of blocks is called a ledger. This ledger is shared among everyone transacting in a public distribution ledger hence, ensuring transparency with zero transaction cost.

In simple terms, Blockchain is a collection of records linked to each other which are strongly resistant to alteration and protected using complex cryptography. It is a system that involves the maintenance of records by everyone instead of a single central authority, a decentralised way of maintaining a ledger.[1] This decentralisation reduces risks of fraud, corruption, and manipulation. Blockchain technology serves as a new and innovative means to implement decentralisation.

Blockchain Technology enables the existence of cryptocurrencies like Bitcoin. Bitcoin is merely a mainstream manifestation of the potential of Blockchain technology. Invented by the mysterious pseudonym Satoshi Nakamoto, Bitcoin is currently the world’s largest cryptocurrency.[2]

How does it work?

The functioning of a Blockchain transaction can be understood based on the following illustration of a transaction between two friends, X, and Y:

  1. Every user in the bitcoin network is in possession of two keys, a Public Key and a Private Key. While the Public Key is an address that is known to everyone in the network, like an email address, the Private Key is a unique address known only to the user, similar to a password.
  2. Supposing X wants to initiate a transaction, X will enter the amount in Cryptocurrency to be transferred, along with X’s and Y’s wallet address through a hashing algorithm. All these transaction details are encrypted using algorithms and X’s Private Key. This serves as a digital signature on the transaction.
  3. This encrypted transaction is now transmitted to the world using X’s Public Key. Though publicly transmitted, the transaction can be decrypted only by using Y’s Private Key.
  4. These transactions taking place all across the world, once recorded is checked by the network. This is performed by persons known as “miners.” The miners are required to solve complex mathematical algorithms to validate the transactions. A miner is rewarded with bitcoins for each such validation. This process of validation is known as “Proof of Work.”
  5. Once validated, the transactions are added to a block. This process is known as Mining. Each block contains a unique code known as a hash.
  6. After Mining, the block is added to the Blockchain and the wallets of both X and Y are updated with the new balances. The hash codes connect the blocks in a particular order.

Any changes made to an original input will produce a new hash. Thus, if someone tries to change even a comma, a new hash is produced while the other blocks in the chain still have the old hash causing discrepancy.

Blockchain Technology Contracts

Blockchain Technology contracts are also known as “Smart Contracts.” Smart Contracts were invented by Nick Szabo in 1994.[3] It is essentially a code that represents self-executing contracts between a seller and a buyer.[4] The code controls the execution of the contract and the transaction involved. The code on Smart Contracts is tamper-evident and tamper-resistant and thus can be used as a trusted third party.[5] A Smart Contract can perform calculations, expose property details, store information and if permitted, transfer funds to other accounts.

Smart Contracts provide attestable data and transparency which fosters trust, reduces cost, and reduces the time taken for completion of the contract, without the interference of intermediaries. Thus, the contracts which earlier required lawyers for creation and escrow services from banks can be replaced by Smart Contracts.

Considering the example of a Smart Contract for the payment of rent: When the tenant pays the rent to the owner in Cryptocurrency, a code carries out the transaction based on the terms of the contract. The owner will receive a receipt upon completion of payment and provides the key to the tenant. Once this contract is completed and released, no one including the owner and the tenant can modify its terms. No physical documents are required for carrying out this transaction and the contract is irreversible.

Companies like Ethereum and Codius[6] currently provide for Smart Contract services using Blockchain Technology. Further, many companies operating on Blockchain technology and Cryptocurrency also support Smart Contracts. 

Smart Contracts in India

In India, Smart Contracts have not been defined in any legislations. However, a notification released by TRAI in 2018 defines Smart Contracts as digitally encrypted agreements codified through cryptography.[7]

Indian jurisdiction does not permit financial institutions to carry out bitcoin transactions. However, under the Indian Contracts Act, 1872, any agreement which involves free consent among competent parties for a consideration with a lawful object is a valid contract.[8] Thus, it is legal for two parties in India to enter into a contract with or without the involvement of intermediaries. The Indian Contracts Act, thus, by definition permits Smart Contracts. Further, Section 5 and Section 10 of the Information Technology Act, 2000[9] recognises digital signatures and considers an electronic contract as valid and enforceable. The RBI via its notification dated 6th April, 2018[10] strictly prohibited all regulated entities from dealing in Cryptocurrency. However, this notification failed to address or regulate Smart Contracts.

The absence of third parties makes Smart Contracts susceptible to frauds and Ponzi schemes. However, Section 65B of the Indian Evidence Act, 1872[11] states that digitally signed contracts are admissible as evidence. Thus, the government and courts can interfere to resolve disputes over Smart Contracts.

Smart Contracts may be enforceable in India but since it creates a platform to transact with anyone across the world, it involves high risk. Thus, if not carried out with caution, the legal system having no intricate system to regulate Smart Contract will not be able to help mitigate the consequences of failed contracts.[12] Therefore, though Smart Contracts are legal in India, the law does not protect the parties engaged in Smart Contracts unless the same falls strictly within the parameters of the Indian Contracts Act.

Advantages of Smart Contracts

  • Smart Contracts allow a safe and secure means of transactions – The data is encrypted through cryptography and the framework of the distributive ledger system ensures data protection. To manipulate information in a single block of the chain, one has to hack all blocks in the chain since they are all related to each other. Thus, Smart Contracts are immutable and incorruptible.
  • Fast Process – The peer-to-peer transaction without the interference of middlemen eliminates human error and ensures swift completion of tasks with great efficiency.
  • Reduced cost – The elimination of intermediaries not only reduces the time required but also the cost involved. Adjacent costs such as commissions, fees, costs of various formalities and paper works, and procedural costs are eliminated.
  •  Transparency – Smart Contracts are made available on a public ledger and is based on transparent terms and conditions. It, therefore, maintains accountability as well as transparency.
  • Storage and Backup – Often important documents are lost or damaged, being written on paper. Smart Contracts are available online in the form of blocks and hence pose no problem of storage, backup, or traceability.

Disadvantages of Smart Contracts

  • Weak and unreliable legal regulation of Smart Contracts increases the risk of transacting over Smart Contracts.
  • Inability to modify contracts. Smart Contracts being immutable, to make even small amends to the contract, a new block is to be created.
  •  In a Smart Contract, ultimately the codes are written by people and they can make mistakes. An example of this was the DAO incident wherein developers’ mistakes in code cost the company and users nearly $60 million.[13]

Conclusion

Blockchain Technology is an ingredient of a new world of technology, maybe even as big as the internet itself. It has commenced a wave of innovation eliminating middlemen and corporate intermediaries in commerce. Though it is now applied only for transfer of Cryptocurrency, Blockchain can be programmed to record and track anything of value including medical records, financial transactions, and even land titles.[14] Further, it can also be adopted in the supply chain to record trades which enables the buyer to check the history of a product. It can also be used to ensure tamper-proof elections and maintain property records to prove ownership.[15] This peer-to-peer transaction method can revolutionise the way we access, verify, and transact with one another.

The implementation and growth of Blockchain enabled Smart Contracts can save billions of overhead costs meanwhile making the system more efficient and transparent. In January 2019 Bajaj Electrics replaced its manual billing system with the safe and fast system of Smart Contracts.[16] This new system has reduced their billing cycle from four-five business days to almost real-time.

With the growth of technology, legislations are always found to be lagging. Law regarding Smart Contracts, Cryptocurrency, and Blockchain remains in the grey. Countries like Switzerland and New Nevada have legally recognised Cryptocurrency and Smart Contracts and made legislative developments regarding the same while other countries are in the process of establishing a regulatory framework.[17] Thus, it is time for India also to establish an intricate and suitable regulatory framework to make the most of this gigantic opportunity.


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