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“On-chain” and “off-chain” arbitration: Using smart contracts to amicably resolve disputes

Recently counsel, arbitrators and potential parties to proceedings have been examining with interest attempts to streamline arbitration using blockchain technology. We mentioned this in our 2018 report for Rzeczpospolita (in Polish), but in the industry so much is happening around “blockchain arbitration” that the issue deserves more attention.

Currently there are at least ten projects around the world, at various phases of realisation, using blockchain to automate alternative dispute resolution at least to some degree. There isn’t room here to describe them all in detail, but Kleros, CodeLegit (discussed also in our earlier publication), Juris and Oath seem particularly noteworthy. We examined what problems they may entail from a legal perspective. All of the comments below are based on publicly accessible materials (such as project websites and whitepapers), but are limited as these projects have not yet been thoroughly tested by end users (tests of beta versions are underway for some of them).

On-chain arbitration: is it true arbitration?

Projects from the category “blockchain arbitration” may be divided into two main groups: “on-chain” arbitration and “off-chain” arbitration.

“On-chain” arbitration involves solutions in which the equivalent of a traditional arbitration award is automatically executed by a smart contract. The key to such projects is ensuring the possibility of execution of the award without the involvement of any third parties and without any additional action by the parties. This may be done for example by the parties making available to the smart contract certain assets (e.g. cryptocurrencies) which, upon occurrence of a defined condition (issuance of an “award”), are transferred from one party to the other. This scenario doesn’t differ greatly from the typical application of a smart contract. The parties may request resolution of disputes by such a mechanism after a dispute has arisen or may provide for it when entering into their contract. On-chain arbitration is an intriguing solution, as in practice it enables a total departure from the traditional system of enforcement of awards in commercial arbitration: if the award is executed automatically, there is no need to examine whether it meets the requirements for enforcement by the state court. Solutions of this type may find use in simple disputes, for example not involving complicated documentation which must typically be analysed e.g. in large construction disputes.

Off-chain arbitration: problems with enforceability of awards

There are many more legal problems surrounding projects that can generally be regarded as “off-chain” arbitration, i.e. without automatic recognition of awards but with automation of certain elements of the procedure before the arbitral tribunal. Many of these projects call for example for automation of the appointment of arbitrators or introduction of elements of game theory into the decision-making process (e.g. an arbitrator should predict how the other arbitrators will vote, and vote accordingly, to avoid losing tokens which are used to increase the candidates’ chances of being appointed as an arbitrator).

This raises doubts whether the state courts will enforce arbitration awards issued using blockchain technology. Problems arise at the stage of the form of the arbitration clause. The New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 1958 requires an arbitration agreement to be made “in writing.” Enforcing an arbitration award issued after conducting an off-chain arbitration pursuant to an arbitration clause contained in a smart contract would certainly not be an easy task for a state court. At the very least, it is uncertain whether a smart contract can be regarded as meeting the condition of written form. Similar doubts apply to the form of the arbitration award, as under the New York Convention the award also must be made in writing.

There are also problems with the manner of selection of the arbitrators and how they reach their decisions, as well as the incorporation of game theory into the decision-making process. It is uncertain whether automatic and random selection of arbitrators ensures their independence and impartiality within the meaning accepted in commercial arbitration. It’s not hard to imagine a situation where arbitrators are selected randomly, but from a limited group of specialists, e.g. in the field of blockchain technology. The risk that arbitrators selected in this manner will not be independent of the parties is quite high.

Forcing arbitrators to anticipate the result of other arbitrators and vote with the majority, despite the arbitrator’s own belief that the award should be different, is also problematic. This could raise problems at the stage of enforcement of the award.

It should also be stressed that the projects providing for ruling exclusively on the basis of documents are utopian, as resolution of disputes, particularly in complicated matters, can rarely be reduced to analysis of documents, but usually requires other forms of evidence, such as the testimony of witnesses.

In short, we take the view that there are certain disputes that could be successfully resolved using arbitration on blockchain. Undoubtedly the use of this technology could be advantageous not only for the parties to such disputes, which would be resolved much faster, but also for the justice system, which could be relieved of the burden of deciding repetitive and relatively simple disputes.

Katarzyna Szczudlik