The second article in a series on the use of blockchain technology in supply chains and projects
Blockchain technology
has been powering the Bitcoin since its inception. It is an ingeniously simple
technology that has immense potential for use in supply chains and projects. It
is a public ledger to which everyone has access. However, at the same time, no
single individual or entity can control it. The technology allows companies and
individuals to collaborate with an unprecedented degree of trust and
transparency. Despite being cryptographically secure, it is fundamentally open.
Blockchain technology is a revolution that begun already and will change the
world. Its impact on supply chains and projects will be unprecedented. Governments
around the world need to be aware of its potential and legislation is needed to
give it legitimacy.
As early as in
1994, Nick Szabo, a legal scholar and cryptographer found that decentralized
nature of cryptography could be used in smart contracts. These are basically
self-executing contracts and ensure the performance of virtual agreements
through blockchain technology. They provide a hassle-free execution of
agreements made between parties. The main property of blockchain technology is
its decentralized nature. This is because it takes away the requirement of
intermediaries. This, in turn, saves a lot of time and prevents any conflict
that may arise due to a third party. A smart contract is a self-performing
contract. The terms of the agreement that exist between a buyer and a seller
are written directly into lines of code. A distributed, decentralized blockchain
network contains the code, which consists of all the agreement terms. In
addition to the agreements, the code also consists of information that executes
the transactions and ensures that these transactions are tracked and are
irreversible.
A smart contract can therefore be
termed as mainly a type of computer protocol. It digitally performs the
function of facilitation, verification as well as enforcement. In other words,
the performance of the contract is self-enforced and digitally recorded. Here
are the key factors of smart contracts:
- The smart contract, once released, can’t be altered by
anyone. No one can change its terms, not even the creator or owner
- The execution and completion of a smart contract does not
require physical preparation and/or submission of documents
- Users can and may be anonymous but, the transaction details
are recorded and registered
- Transactions of smart contracts can’t be revered
Smart Contracts & How They Work
The terms and
conditions of a smart contract are engraved in the code itself. Typically, a smart
contract interprets, verifies, and automatically executes any transaction laid
down in the terms and conditions. Let us take a rental contract, for example. When
it is made into a smart contract, we will see its efficacy and effectiveness.
The tenant pays the rent to the house owner in cryptocurrency. As soon as the
payment is made the code carries out the transactions in accordance with the
terms of the contract as entered into the code. The landlord receives an advice
when the transaction is successful and will issue a receipt. The first-time
deposit and advance that are paid will lead to the release of the house key.
The system operates on the If-Then principle. Whoever is involved in the
blockchain will observe the transaction and become witness to the contract. The
record of payment and key release are visible to all concerned. One action will
not be completed without the other. What could be a more efficient and
effective system than this?
Smart contracts
specify the rules and penalties related to an arrangement in the same manner
and format as a conventional contract. They also implement those obligations
automatically. The contracts are implemented using a platform, which consists
of two elements, currency and contracts. Smart contracts are essentially agreements
in electronic form rather than paper. So, the question is ~ what is its legal
status? Can they still be regulated by the existing legal framework? Do they
require a new legal system to govern them? We shall see.
Secured
Transactions & their Benefits: With smart contracts transaction can be
carried out and terms can be enforced seamlessly between the parties concerned.
The concept of a smart contract is that while one person gains something of
value in return to the second party being paid. The absence of intermediaries
makes it easy to enforce. In the non-smart era implementation wouldn’t be as
seamless. Often third parties, usually in foreign countries, are part of the
contract. This makes enforcement complicated. Blockchain platforms have made
this possible. The networks are transparent as is the ability to determine and
formulate who has priority over the funds in question. Parties can therefore
easily accept or reject certain terms thus promote quicker and more efficient ways
to implement contracts.
Regulation of
Smart Contracts Around the World: Under contract laws applicable almost
universally, a conventional contract must contain the following elements to be considered
as valid:
- A legitimate offer
- A properly communicated acceptance
- Enforceability by lawful
- Consideration
- Consent of all competent parties in regards to all aspects of
the contract
The Uniform Electronic
Transactions Act (UETA) serves as a framework that states
can use in order to determine the legal status of electronic signatures. It is
not a federal law. As many as 47 states have passed and started enforcing it
since 1999. UETA places regulations on electronic contracts, records and
signatures. It states that electronic contracts and signatures are valid. They
constitute a legitimate way of providing contractual consent. In the European Union
(EU), Rome I Regulation is the legislation which determines the legality
of all EU civil and commercial contracts. The Rome I Regulation governs the choice of law
in the European Union.
Overview of Contract Law in India
Contracts
in India are governed by the Indian Contract Act of 1872. It lays down the
basic elements under which contracts are enforced and governed. Section
10 of the act states that “all agreements are
contracts if they hold the free consent of parties willing to contract, for a
lawfully accepted consideration and with an object.”
For an agreement
to be enforceable by law it must consists of an offer, acceptance and
consideration. By definition, it would be construed therefore, that smart
contracts are valid under the Indian Contract Act 1872. A smart contract
consists of the offer, the acceptance and consideration in the form of
cryptocurrency. Cryptocurrencies are not consideration as legal tender under
Indian law. Therefore currently, these are not enforceable and hence don’t constitute
a contract. Section 5 & 10 of the Indian Information Technology Act 2000
states that electronical signatures are legally accepted. So, a contract is legitimate
and enforceable if it is prepared and signed electronically. Section 65B of
the Indian Evidence Act 1872 states that contracts digitally signed
shall be admissible in the courts.
So, what about
smart contracts in India? Smart contracts
basically provide a platform for contracting parties who do not know each other.
Not that parties who know each other are excluded. Every contract involving
exchange of goods/services and money is prone too many risks. Smart contracts
can help mitigate this problem. However, the Indian Contract Act is the law
which will regulate the contract. So, to be enforceable under Indian law, due caution
must be exercised. Although electronic documentation and signatures are valid,
the Indian Contract Act needs to be amended to make all smart contracts legal.
For example, the absence of consideration should not render the contract null
and void. So, though smart contracts are legal in India, several provisions
need to be added to it to make it compatible with the Indian laws. For a smart
contract to be valid it must fall within the boundaries of Indian contract law.
Risks of
Smart Contracts: Today, Indian law allows electronic contracts and
signatures. However, several Ponzi schemes which succeeded in duping many
people indicate that there is lack of desired safety in electronic documents.
Will blockchain technology help in safeguarding people’s interest? As things
stand, there are no well-established legal frameworks to regulate
Crypto-transactions, not just in India but almost everywhere else in the world.
Section
35 of the of the Information Technology Act, 2000,
regulated electronic signatures. It states that “Any
person may make an application to the Certifying Authority for the issue of a
Digital Signature Certificate in such form as may be prescribed by the Central
Government.” This raises a problem as far as smart contracts and
blockchain technology are concerned. When using blockchain technology, the hash
key is self-generated. It is the hash key that is used as an identifier to
authenticate the smart contract. Under the Indian legal system today, there is
no legal authority that regulates blockchains sanctions electronic signatures
in the form of hash-tags. There is a dire need for legislation in this
direction.
Section 88A of
the Indian Evidence Act 1872 states that “The Court may presume that an
electronic message, forwarded by the originator through an electronic mail
server to the addressee to whom the message purports to be addressed
corresponds with the message as fed into his computer for transmission; but the
Court shall not make any presumption as to the person by whom such message was
sent.” Explanation. –– For the purposes of this section, the expressions
“addressee” and “originator” shall have the same meanings respectively assigned
to them in clauses (b) and (za) of sub-section (1) of section 2 of the
Information Technology Act, 2000 (21 of 2000).
So, under the act
the court presumes that an electronic record produced in court is genuine.
However, it does not make any presumptions about the sender of the contract. So,
if a signature obtained using blockchain technology, what will be its status?
Und the act, it will only be admissible if the signature is obtained as per the
provisions of the Information Technology Act. Unfortunately, this not only
vitiates the system of encryption present in the blockchain technology for
smart contracts, it also disallows their use. That is why we need legislation,
maybe a brand-new evidence act, to replace the existing one. Remember, the
current one is close to a century and a half old.
Despite the
absence of legislation, some businesses have already started using blockchain
technology and smart contracts to conduct their business.
One such company is Bajaj
Electricals, a leading manufacturer of a wide range of electrical equipment. The
company, one among the Bajaj Group of Companies, is perhaps a key player in this
industry. Its business activities affect several sectors, not just channel
partners and vendors internal & external, within India and abroad. One of the
biggest problems for vendors, whether supplying goods or rendering services, is
that payment processes are always cumbersome. Payments are forever delayed and
this badly affects their cash-flows. In most cases, customers deliberately
delay payments but, even if they don’t, the very act of processing documents
and payments plus the money transfer mechanism, leads to delays. This happens
even in this day and age of electronic documentation and payments. How Bajaj
Electricals dealt with this issue makes an interesting case-study. [see: https://www.livemint.com/Companies/BcqXQgey9fieFps9xVZxrK/How-Bajaj-Electricals-uses-blockchain-to-pay-suppliers.html
][also, https://www.thefuturescentre.org/signal/bajaj-electricals-in-india-uses-blockchain-to-pay-suppliers/
]
According
to the report in the Mint getting paid for the material they supplied to Bajaj
Electricals Ltd was a cumbersome process for vendors. It involved several steps
that included confirmation of delivery by Bajaj Electricals, raising of a
physical bill of exchange by the supplier and submission of invoice and
transport documents to Yes Bank Ltd, for payment.
This
prompted the Bajaj Electricals management to explore a speedy and secure
solution to replace its manual bill discounting process. The solution they hit
upon was blockchain. In January, the company announced going live on a
blockchain-based vendor-financing (also known as supplier financing) solution
developed by Yes Bank. The use of blockchain technology eliminated the manual
steps involved in the company’s bill discounting process and the entire
transaction is now paperless. [Click on the link above for the full report]
Besides Yes Bank,
the Mahindra Group and IBM are pursuing and experimenting with supplier finance
blockchain. This was revealed in November 2016 that they are co-developing a
cloud-based blockchain framework with the potential to reinvent supply chain
finance in India. [Details available in these reports: https://cointelegraph.com/news/tech-mahindra-employs-ibm-blockchain-in-new-platform-to-combat-digital-piracy
& https://mediacenter.ibm.com/media/Mahindra+Group+unlocks+the+disruptive+potential+of+IBM+Blockchain+technology/1_0qnjw112
]
Meanwhile,
the Institute for Development and Research in Banking Technology (IDRBT)
has come out with a blueprint of blockchain technology for the banking sector.
The institute has been working with government, banks and industry for building
a blockchain that can serve as a common platform to launch varied applications.
[see: https://www.financialexpress.com/market/idrbt-proposes-road-map-for-blockchain-technology/1451854/
]
There is no question that the
implementation and growth of smart contracts is the next step of innovation. It
can lead directly to billions of overhead costs being minimized while making
the whole system more efficient. Regulatory issues, however, exist, especially
in India where there are no regulations regarding the finer details of a smart
contract. If specific regulations are not made, a wide-ranging adoption of the
technology will require the government to make amendments to the Indian
Evidence At, 1872 and the IT Act. Therefore, although there is a certain amount
of progress in government thinking and more businesses are adopting the smart
contract concept, the law is still functioning in a grey area. Legislation is direly
needed to establish an intricate framework within which to regulate the
functioning of smart contracts in India.
https://www.livemint.com/money/personal-finance/blockchain-in-personal-loans-how-it-will-redefine-the-future-of-lending-11734938973041.html
