As the technology improves the way has to be found to regulate and control such arrangements in order to protect the consumers, investors, the integrity of the market and public interest in general, while not hindering the innovation. Since smart contracts have some similarities to legal contracts some jurisdiction regulated them under the traditional civil law definitions[1]. In contrast to these jurisdictions Malta was focused on the Blockchain technology itself.

The Blockchain Strategy[2] of the island aims to attract the enterprises with the safe legal environment ensured by the Blockchain legislation and an innovation friendly environment by applying the technology in different sectors like education, public registries, public administration and governance.

In the frame of the Blockchain Strategy three bills have adopted and entered into force last year.

  1. The Malta Digital Innovation Authority Act (MDIA Act) established an Authority (MDIA) and regulates its duties and responsibilities to certify DLT platforms. This certification of the DLT platforms confers credibility and legal certainty to its users and operators.
  2. The Innovative Technology Arrangements and Services Act (ITAS Act) regulates the regime for the registration of service providers, the services and the certification of technology arrangements.
  3. The Virtual Financial Assets Act (VFA Act) sets up the framework for ICOs and the regulatory regime for certain services and service providers in relation to virtual currencies.

In this Article:

  • Part 1: the smart contracts and the referred Blockchain regulation will be examined through the traditional civil code categories on contracts and
  • Part 2: the lifecycle including the dispute resolution techniques.

According to the Section 960 of Civil Code of Malta

contract is an agreement or an accord between two or more persons by which an obligation is created, regulated, or dissolved.

The essential elements of the contracts are

  • the capacities of the parties,
  • the consent,
  • certain thing which constitutes the subject-matter and
  • a lawful consideration.

Based on the Virtual Financial Act

smart contract means a form of innovative technology arrangement consisting of:

  • a computer protocol; and, or
  • an agreement concluded wholly or partly in an electronic form, which is
  • automatable and enforceable by execution of computer code, although some parts may require human input and control and which may be also
  • enforceable by ordinary legal methods or by a mixture of both.

Nick Szabo introduced smart contracts in 1997 with the simple examples of a vending machine and an ownership management of a car between owner and financing bank.

Smart contracts are already capable to interact with each other, run autonomously as defined by the code without any human interaction.

Such platforms called Decentralized Autonomous Organization (DAO). Taking into consideration such functions and the possibility of the future development, the smart contracts are regulated under ITAS Act as “innovative technology arrangements”.

Such technology arrangements encompass DLT platforms, smart contracts and related applications, including DAOs, and any other arrangement designated by the Minister responsible for Digital Economy, which gives a possibility to follow the technical improvement. The certification by MDIA is voluntarily.

A smart contract especially if it was created for enforcing one obligation on the Blockchain platform, still shows some similarities with legal contracts. Accordingly smart contracts can support the performance or in certain cases they may be used even more effectively than legal contracts by reducing the costs, administration, building trust amongst the parties by eliminating intermediaries.

Essential elements of the contracts

The first essential element of the contract is the capacity of the parties. In a certain stage of the technical improvement besides natural person and organizations with legal personality or without it, new categories might be introduced as subjects of legal acts.

With the improvement of technology more and more things will be connected to the internet (Internet of things, IoT) sharing and getting information to act accordingly and interacting with each other through DLT platforms. As referred above smart contracts interacting with each other can create a DAO.

The responsibility for the damages caused by such automated decisions and actions shall be regulated in the future.[3]

Since all transactions are saved by all nodes on the Blockchain, they are public including the public key of the user. Each user has a private key that gives them access to their virtual wallet.

Public key consists of signs, letters and numbers, the users can not be identified by the community, hence the parties entering into a transaction on the Blockchain do not need to trust each other, they even might not know each other, they just need to trust the system.

Due to this privacy Bitcoin was used for trading with illegal goods and services by criminals through online marketplace “Silk Road”.

The main challenge is to identify the users and ensure their capacity (e.g. age in a case of natural person, or legal status of a company).

In Malta innovative technology arrangements shall meet

  • general standards of legality, integrity, transparency, compliance and accountability.
  • Service providers have to ensure the proper personnel and the financial resources to meet the compliance and operational obligations on the one hand, while the technology arrangements, administrators, technical administrators, qualifying shareholders, system auditors, themselves are subject to a fit and proper test based on the guidelines of MDIA or other authority on the other hand.

 

Consent of the parties is essential for legal contracts; however smart contracts may not necessarily have two parties[4]. Based on Section 974 of Civil Code where consent has been given by error, or extorted by violence or procured by fraud, it shall not be valid. If smart contract is programmed based on a legal agreement of the parties, the intention of the parties and the consent can be examined according to the general rules of the Civil Code. In a case the agreement of the parties shall be considered voidable or void some traditional consequences might not be applicable (e.g. in integrum restitutio) after launching the smart contract.

Users transacting on the Blockchain or deciding to use such applications could be exposed to fraud. During the hype in 2017 “over 70% of ICO funding (by $ volume) went to higher quality projects, although over 80% of projects (by # share) were identified as scams[5].

The aim of the Maltese legislation is to ensure the legal certainty in this sector. Providing authentic information on the certified innovative technology arrangements is essential for the users, accordingly MDIA shall maintain on its own website a publicly accessible electronic register of all recognition issued or obtained.

The register shall contain:

  • data of the relevant applicant,
  • its activities and
  • other relevant information determined by the MDIA.
  • Moreover the certified innovative technology arrangement itself and the registered service provider shall post the certification, in a specific location, in an easily accessible and legible format so that it can be viewed and understood by the users.

 

The subject-matter has to be lawful. According to the Civil Code things which are impossible, or prohibited by law, or contrary to morality, or to public policy, may not be the subject matter of a contract.

As referred above Blockchain ensures high privacy to its users, so Bitcoin was used by criminals to trade with illegal products in the past.

To avoid such illicit activities, MDIA may certify different innovative technology arrangements for one or more specified purposes and with reference to one or more specified qualities; features; attributes; behaviours; or aspects.

During the examination the authority has to consider the protection of the general public, the competition, the transparency and the general market impacts.

MDIA has to monitor the operation of such innovative technology arrangements to prevent money laundering and funding of terrorism.

The authority through its regulatory powers may require information, refuse, revoke, cancel, suspend any technology arrangement authorization, and impose administrative fines.

 

Lawful consideration is fundamental for the legal contracts. According to Section 990 of Civil Code the consideration is unlawful if it is prohibited by law or contrary to morality or to public policy.

The transactions on the Blockchain are usually paid by crypto currency, which still can be considered as a challenge for the legislators.

  • Some countries have already adopted or on the way to set up regulations on crypto currencies (e.g. Switzerland, Malta, Germany, France);
  • however in some countries trading with them is prohibited (e.g. Saudi Arabia, China).

The unsure legal environment itself affects the value of such currencies and turns the investments more risky in those countries which have not published a clear position. Accordingly it was crucial for Malta to adopt regulations in this field in the frame of the Blockchain Strategy.

ICOs, virtual tokens, exchanges are regulated by VFA act and licensed by MDIA and Malta Financial Services Authority acting jointly.

According to VFA Act a virtual financial asset means any form of digital medium recordation that is used as a digital medium of exchange, unit of account, or store of value and that is not electronic money; a financial instrument; or a virtual token.

Financial instruments test shall be run regarding such financial assets to understand which law is applicable.

  • Utility tokens, not exchangeable and not having any values outside the Blockchain might not fall under VFA act, however
  • security tokens providing passive income based on the underlying security shall be regarded as financial instrument under MiFID.

Taking into consideration the high importance of this sector obtaining the license for innovative technology arrangements regulated by VFA Act is obligatory.

[1] US states Arizona and Tennessee recognized smart contracts as legally enforceable contracts in digital form. https://publications.tnsosfiles.com/acts/110/pub/pc0591.pdf and https://legiscan.com/AZ/text/HB2417/id/1497439

[2] https://chainstrategies.com/2018/02/18/maltas-national-blockchain-strategy-the-big-picture/

[3] The Blockchain Strategy of Malta has a project for e-residency and digital identity (of individuals and legal entities) on the Blockchain.

[4] E.g. In a case of a virtual piggy bank, where the smart contract is created by the user to save money, no other party is involved until DLT platforms has no legal identity or personality. This characteristic is also acknowledged by VFA ACT, since the definition of smart contract refers to a computer protocol without involved two parties.

[5] https://research.bloomberg.com/pub/res/d28giW28tf6G7T_Wr77aU0gDgFQ