“SMART CONTRACT” IN HASTE, REPENT AT LEISURE?
In Which I Borrow Four Marriage Concepts To Educate Digital Platforms On (Easy) Risk Mitigation
This piece aims to provide an “easy-to-read” explanation of why start-ups operating blockchain-enabled digital platforms should take risk mitigation seriously- in particular, contractual risk mitigation through the simple act of applying specific terms to the use of the platform.
Risk Mitigation: Something Old, Something New and Something Borrowed
Now, I fully understand that talking about risk doesn’t make you popular with start-up founders who live and breathe risk on a daily basis.
What I have to say to start-up founders re risk is well-summed up in this quote from Benjamin Franklin about marriage:
“Keep your eyes wide open before marriage, half shut afterward.”
That is to say, here is what start-up founders need to consider: There is a big difference between embracing risk blindly right from the start and a calibrated and nuanced embracing of risk through a sensible risk mitigation strategy that still allows you to achieve your business goals in (relative) peace.
And this “health warning” derives from something old: risk mitigation based on having (legal) usage terms in place between digital platforms and their users, which addresses, broadly speaking, the following questions:
· Who Does What When?
· What Happens When the Music Stops?
And while contractual risk mitigation is not a bulletproof tool (eg. if local consumer laws override freedom of contract), it is still a very powerful equivalent of a protection shield within the universe of legal risks.
And both of these “somethings” equally apply to the something new that is Blockchain.
While my takeaways apply to all digital platforms, my piece is particularly addressed to founders of blockchain-enabled platforms.
And that is because it is this class of founders who I have found to be particularly averse to leveraging any sort of risk mitigation tools from the traditional industry: Drawing on their view of it as a Dark Art rather than recognizing it for the low-hanging (risk mitigation) fruit that it is (Read more on my views on this here.)
1. I Do (Remain Liable Even When I Think I Don’t)
How exactly the traditional legal regime applies to certain unique operational aspects of a digital platform remains an open question as of date.
However, what is clear is that it applies. And therefore, I would like to lay to rest one mistaken assumption that I have found many blockchain enthusiasts operating under: that the decentralised nature of the blockchain technology underlying their platform somehow absolves them from legal liability for the operation of the platform. A related assumption is that “smart contracts” replace legal contracts in their entirety as a risk mitigation tool.
How traditional dispute resolution forums will interpret contractual terms in specific scenarios involving digital platforms will remain an unfolding drama for some time. However, even within our current “gray zone”, there are still several basic legal risk mitigation tools (Eg. “health warning” on risk factors including the ever-changing regulatory landscape, a user’s responsibility to keep their access information safe etc) that can be deployed easily and effectively.
To further clarify, the takeaways in this piece apply to practically any kind of digital platform - I have had personal experience of deploying contractual risk mitigation tools for businesses as diverse as:
· Cryptocurrency trading (including leveraged trading)
· Listing of Security Tokens
· Trading of Digital Collectibles
And it goes without saying that you should absolutely have written terms in place if you’re raising any funding or pre-funding for a project — Separate piece on this to follow.
2. With this ring I do thee “data-protect”
Much has already been written about how the decentralized nature of the blockchain is incompatible with current privacy laws. However, for the foreseeable future, it doesn’t appear that any exception will be forthcoming. And in fact, privacy laws pretty much across the world continue what can best be described as a relentless march towards an increase in scope and reach accompanied by increased scrutiny from privacy regulators.
Besides, digital platforms are likely to be dealing with more and more personal data going forward- As regulators across the world increase their focus on “old school” compliance (i.e. matters such as AML, CFT and sanctions compliance) in the “new age” space. A significant component of the processes and procedures that underlie this compliance architecture relies upon identity checks which therefore enhances the need for privacy compliance.
Founders of digital platforms should bear in mind that the fundamentals of privacy compliance are broadly the same across the world- the need for consent to process data, the requirement to notify the subject of the purpose and responsibility for data protection even when the actual data processing is outsourced to third parties.
3. Choosing Your Battles (Or The Site Thereof)
One of the very valuable functions of documenting the terms of service is as follows: in addition to contractual risk allocation, it allows founders to access a vital risk mitigation tool in terms of specifying the governing law and jurisdiction. In layman’s terms, this is choosing the turf for the war.
Generally speaking, courts across the world do recognize the freedom of parties to make this choice which makes this a particularly valuable legal tool.
Having a sophisticated court determine the rights or obligations of a “new age” business is extremely important — as, by their very nature, they aren’t run-of-the-mill cases and require a careful and detailed analysis of a myriad of issues at the intersection of law and technology.
Transaction parties need to carefully consider whether the courts that they are choosing would be willing and able to undertake such a sophisticated analysis. It is of course certainly worth considering the Singapore courts as an option- given the recent example of the B2 C2 Quoine case in which the Singapore courts undertook precisely such an analysis while adjudicating on certain automated transactions conducted on a digitized trading platform.
More practically you can get options of less intrusive and potentially less expensive forms of dispute resolution such as arbitration and mediation. Mediation has gotten a shot in the arm recently with the advent of the Singapore Convention on mediation- See here for more information.
4. Making a Thing of Value a Joy Forever
Here is a “sleeper” development in the blockchain legal space that is often missed by the business folks —While we are tying ourselves in knots over whether a particular digital asset is a commodity or a currency, slowly but surely, cryptocurrency has been implicitly recognized as property even without any underlying collateral or inherent value. This development has taken place outside the noise and fanfare of regulatory action through the court process- including freezing orders for the recovery of cryptocurrency as property in cases involving the collapse of digital asset exchanges and for the recovery of the proceeds of money laundering.
So why does this matter? To take just one example, say you are a digital platform that accepts payments for services from users in cryptocurrency.
Say you are then in the unfortunate position of having to refund the cryptocurrency for any reason (say there has been a technical glitch in your system or a regulatory action requiring to reverse a particular payment). What is the cryptocurrency entitlement of a user in that scenario?
Is it the exact amount of Bitcoin that they paid to you initially? (Which may have been worth USD 14,000 at that time in contrast to the dizzying height of USD 38,000 that it occupies in early Feb 2021)? The fiat value at the time of payment? The fiat value at the time of refund? Or some other formula?
Founders should note that this is not a theoretical issue to be scoffed at- This was precisely one of the contentious points that came up in the insolvency proceedings of the Mount Gox cryptocurrency exchange (as part of the other “hot button” issue of whether the upside from the surge of Bitcoin prices is owed to shareholders or customers of the exchange).
Clarity on the all-important matter of financial obligations is something that can be done quite effectively through a set of contractual terms (it must of course be accompanied by the careful backend treasury management required to honour actual or expected financial obligations as and when they arise).