The Limits of Code Deference
The Journal of Corporation Law, Forthcoming
29 Pages Posted: 16 Aug 2021
Date Written: July 19, 2021
Using smart contract technology, entrepreneurs have created technical structures that allow their users to access novel financial services that operate without legally addressable counterparties and enable groups of people to act collectively to affect rights to digital assets. We call these various structures “decentralized ventures.” These decentralized ventures enable transactions among their participants in accordance with rules created and enforced by their code; human participants in these decentralized ventures interact with the venture, and sometimes with each other, using smart contracts. Smart contracts, however, may be flawed or behave in unexpected ways. What happens when a smart contract defect or error harms a decentralized venture participant? Some participants may sue, seeking damages, to reverse the smart contract outcome, or to enjoin the venture’s ongoing operation. Litigation over smart contract outcomes may disrupt—if not destroy—decentralized ventures and may have widespread unintended negative effects upon the rights and property of other decentralized venture participants and on third parties.
Many decentralized ventures attempt to prevent their participants from suing over smart contract outcomes by requiring that their human participants defer to and agree to be bound to the outcome of smart contract execution. We call this concept “code deference.” Code deference is critical to the orderly operation of decentralized ventures but has received little attention in the legal literature. This article examines legal and technical attempts to impose code deference on human users of certain types of decentralized ventures. It addresses strategies observed in practice, ranging from generalized obfuscation and on-system dispute resolution, to waivers and contractual covenants not to sue. And it examines other proposed strategies not yet observed in practice. It is likely, however, that, absent significant legal reform, no approach based in code or in law can prevent a lawsuit over a smart contract outcome.
While absolute code deference may never be achievable, code deference attempts should be viewed as mechanisms to rebalance incentives by increasing the opportunity costs for a decentralized venture participant to sue over a smart contract outcome and providing efficient alternatives to litigation. Even with inherent limitations, code deference provisions may functionally create code deference in all but a narrow set of circumstances. Effective incentives toward code deference move participants in decentralized ventures closer to the ideal of systems that allow parties to transact using rules created and enforced by code rather than rules created and enforced by a legal system.
Keywords: smart contract, smart contracts, blockchain, blockchains, DLT, DLTs, distributed ledger, ethereum, decentralized, decentralized application, dapp, decentralized organization, decentralized autonomous organization, DAO, code, code deference, theDao, The Dao
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