Code is not law - Arbitration's critical role in resolving crypto disputes

Market volatility breeds disputes, and the ‘Crypto Winter’ is no exception. Crypto-related disputes are on the rise, and they can take many forms. From traditional disagreements about the meaning of a contract to technical disputes about the operation of particular networks, software or transactions — arbitration has established itself as a preferred forum.

THE CONTENTIOUS SIDE OF CRYPTO

Crypto-related disputes generally involve familiar legal issues, but many also require novel application of established legal principles, given the unique characteristics of distributed ledger technology (DLT), digital assets and the broader Web3 environment. However, there are common features to all crypto disputes, whether the issue is about ownership and governance of a particular project or company, legal rights arising from control of digital assets, liability for misappropriated cryptocurrency or the impacts of regulatory change. These disputes generally involve assets and parties across multiple jurisdictions, operating in nimble markets where speed counts.

WHY YOU NEED A LEGAL DISPUTE RESOLUTION MECHANISM

Code is not law: while code executes in a pre-ordained way, those online actions, and the participants in the relevant transaction, cannot (and would not want to) altogether escape the reach of the law. Indeed, legal certainty is the bedrock of business operations. It is the law that ensures parties can protect their investments and would not, for example, be held to the output of obviously erroneous code or a transaction brought about through fraud. As such, parties’ online relationships and the contracts that govern them require legal rights that can be upheld and enforced both online and in the physical world. While self-executing smart contracts and Web3 applications may promote certainty and efficiency in commercial dealings, being able to compel a party to take action beyond what the code requires is essential. Because of that, it is important commercial relationships in Web3 are anchored within a valid legal framework and that parties identify, at the outset of their transactions, the dispute resolution mechanism that will apply if things don’t go to plan. Parties who disregard these realities face substantial legal risks. Determining how and by whom disputes will be resolved is a real entanglement, with real-world uncertainty and costs. Procedural disagreements that result from a failure to consider upfront how disputes would be resolved can lead to years of delay and unnecessary legal costs. This can significantly hamper growth and expansion of a business, as well as shareholder returns. The decentralised and borderless nature of DLT and its users only exacerbates already complex conflict of law issues in this context.

WHY ARBITRATION IS WELL-SUITED TO RESOLVING CRYPTO DISPUTES

Arbitration is a non-national and neutral dispute resolution forum, which results in a final and binding legal award enforceable around the world. It is also a process with party autonomy at its heart, such that parties can choose the shape and characteristics of the process for resolving their disputes. The flexibility of the arbitral process – with the procedure tailored by the parties’ agreement – enables the parties to, for example, nominate a tribunal of industry or technical specialists. This is particularly appealing in crypto disputes, due to potential complexity of the legal and technical issues that may arise. The broader flexibility that arbitration affords (when considered carefully in the context of the laws that would apply to the arbitration) also enables parties to tailor the arbitration to best meet their commercial objectives.

IS ARBITRATION FIT FOR WEB3?

Despite being more flexible than court litigation, arbitration can still be a lengthy and costly process involving submissions, document production and factual and expert witnesses. For complex and high-value cases, a detailed process with full exchange of evidence and submission is often desirable to ensure justice is done. However, parties can agree to streamline the process to better fit with their commercial drivers. As discussed above, parties can limit the disclosure exercise in advance, forgo an oral hearing in favour of a decision ‘on the papers’ or limit the number of factual/expert witnesses and/or arbitrators. A still-nascent area of online dispute resolution seeks to embed arbitration processes within smart contracts/software. Notwithstanding the exciting potential for on-chain arbitration, the ‘code is not law’ disclaimer applies here too: an arbitration protocol running on a blockchain (and its output) must be consistent with the mandatory laws that apply to the transaction and, therefore, enforceable in the real world. It must include legal safeguards necessary to address unforeseen contingencies or coding/software bugs. A failure to do so will see such protocols add time and complexity to the resolution of disputes, rather than the opposite. Again, this militates in favour of parties taking specialist advice before deciding how best to resolve disputes that arise from their relationship. Failing to do so can have costly consequences financially and in the implementation of a business’ vision.

WHAT NEXT?

DLT and its applications continue to mature notwithstanding the ‘Crypto Winter’. The trend is towards greater decentralisation of business processes and relationships, across multiple jurisdictions. This trend holds true in both the B2B and B2C contexts. As digital asset and Web3 companies continue to buy, build and grow, they need to think carefully about how disputes (which are unfortunate but inevitable over the life of a business) will be resolved. In particular, how they are resolved in a manner that best meets operational needs, but also ensures maximum certainty and enforceability of legal rights. In addition to thinking about contractual remedies and disputes, businesses should also reflect upon how to structure their investments to ensure they are protected under available international treaties too.

For further information, please contact Simon Chapman, Partner, Charlie Morgan, Senior Associate, or your usual Herbert Smith Freehills contact.

The authors would like to thank Dan Huang for their assistance in preparing this blog post.