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The State of Arizona has passed a ground-breaking law confirming that smart contracts and blockchain-based signatures have the protection of its Electronic Transactions Act.1
A type of decentralised database (often called a ‘distributed ledger’) that keeps records of digital transactions. Instead of relying on a central administrator – as in the case of a traditional database – the blockchain relies on a network of replicated databases which automatically synchronise. The decentralised database records are visible to anyone within the network. The blockchain network can be private with restricted access (a ‘permissioned ledger’), or open to and accessible by any person in the world. The blockchain is often described as being ‘immutable’ because once data has been written to a blockchain, it cannot be changed as a consequence of the decentralised network automatically updating. This means it is resistant to fraud or hacking. The crypto-currency bitcoin was the first publicised application of the blockchain, but its potential applications are vast because it is a trusted method of tracking ownership of any assets or rights without the need for a central authority.
A set of promises written in code – rather than in natural language – which are self-executing in the sense that they are performed automatically when defined criteria are met. Smart contracts do not need a blockchain to work, but they do need an underlying trusted network or mechanism. Therefore, the ascendance of the blockchain as a commercial network has intensified interest is the use of smart contracts because it is an efficient and trustworthy network upon which smart contracts can be concluded. Lawyers are quick to point out that smart contracts raise many legal questions, including in relation to privacy, data protection, transfer of title, termination and remedies. For that reason, in the near-term, smart contracts will be used only for relatively simple contracts involving unambiguous payment flows, identity verification or index pricing, until the technology can accommodate the complexity and nuance of most commercial contracts.
The Arizona Electronic Transactions Act (the
Arizona ETA) provides that records or signatures in “electronic form” cannot be denied legal effect and enforceability based on the fact they are in electronic form. The legislation was originally enacted in 2000 to confirm that electronic records and signatures can be as valid as conventional ‘hard copy’ manuscript records and signatures.
Last month’s amendments to the Arizona ETA brings the law up to speed with latest technological developments, by confirming that blockchain technology is “electronic” for the purposes of that Act, and can give rise to valid legal contracts. Specifically, the amendments confirm that:2
- A record or contract that is secured through “blockchain technology” is considered to be in an electronic form and to be an electronic record.
- A signature secured through “blockchain technology” is considered to be in an electronic form and to be an electronic signature.
- A contract relating to a transaction may not be denied legal effect, validity or enforceability solely because that contract contains a “smart contract” term.
For this purpose:
- "blockchain technology" is defined to mean distributed ledger technology that uses a distributed, decentralised, shared and replicated ledger, which may be public or private, permissioned or permissionless, or driven by tokenised crypto economics or tokenless. The data on the ledger is protected with cryptography, is immutable and auditable and provides an uncensored truth.
- “smart contract" is defined to mean an event-driven programme, with state, that runs on a distributed, decentralised, shared and replicated ledger and that can take custody over, and instruct transfer of, assets on that ledger.3
The Arizona amendments also clarify that a person who uses blockchain technology to secure information that the person owns or has the right to use “retains rights of ownership or use with respect to that information” in interstate or foreign commerce.
Aside from clarifying the legal status of blockchain-based information, these amendments also reveal the increasing prevalence of blockchain applications in global commerce. The Arizona congressmen who lobbied for the amendment to the Arizona ETA are strong advocates of the technology and are playing a key role in shaping federal FinTech policy. Eight other US states are expected to pass laws expressly recognising blockchain technology in 2017, following February’s launch of the United States’ bipartisan Congressional Blockchain Caucus, which will develop federal public policy for blockchain-based technologies and digital currencies.4
How is this relevant to New Zealand?
The New Zealand Electronic Transactions Act 2002 (the
New Zealand ETA) shares many similarities with the Arizona ETA. Both are among the 65 statutes worldwide which are based on the model law developed by the United Nations Commission on International Trade Law (UNCITRAL).
Like the Arizona ETA, the New Zealand ETA’s default position is that a signature or other information is not denied legal effect solely because it is in electronic form or in an electronic communication.
The New Zealand ETA does not exhaustively define what is “electronic”; rather, it states that ‘electronic’ “includes electrical, digital, magnetic, optical, electromagnetic, biometric, and photonic”. The Arizona ETA’s definition is very similar, defining “electronic” to mean “relating to technology that has electrical, digital, magnetic, wireless, optical or electromagnetic capabilities or similar capabilities.”
Therefore, the fact that the State of Arizona has seen the need to expressly clarify that “blockchain technology” is “electronic” for the purpose of the Arizona ETA raises the question – does the New Zealand ETA require similar updating?
Our Parliament is likely to respond ‘no’, citing the principle of “technological neutrality” – which underpins the UNCITRAL model law – and advocates laws which focus on the characteristics that technologies should display in order to be compliant, rather than the specific technologies themselves.
The principle of technological neutrality is sensible in theory because it avoids the need to keep updating the legislation as new technologies emerge and others are superseded. However, in practice it can be difficult to apply principles-based legislation to new and sophisticated technologies when those charged with its application (lawyers, regulators and courts) are likely to lack the detailed knowledge of the technology necessary to reach a definitive view. This leads to uncertainty, which undermines efficient markets and results in unnecessary cost and risk for contracting parties. Uncertainty is also inconsistent with the stated objective of the New Zealand ETA to “reduce uncertainty regarding the legal effect of information that is in electronic form or that is communicated by electronic means”.
While blockchain technology and smart contracts are still an emerging feature of New Zealand’s legal landscape, the pace at which they are moving into mainstream commerce cannot be ignored. Our policy-makers should closely monitor developments in this area and consider issuing guidance to the market as to how to apply the New Zealand ETA to these technologies if statutory amendments are not deemed to be necessary.