ABSTRACT
The creation of smart contracts became possible with the development of the technological infrastructure, blockchain technology. This article explains the provision of judgment and execution of smart contracts by the parties, the brief history, features, working principles, and importance of blockchain technology under Turkish law. In addition, issues related to the provisions of a smart contract and contract terms are explainedwithin the scope of Turkish law, and its connection with smart contracts is mentioned.
Digitalization exists in every field today and is changing the way we do business. These changes came about through the reliable, fast, cheap, and quality digital services aimed at eliminating the most inefficient and risky elements of each sector.
I. INTRODUCTION
Digitalization exists in every field today and is changing the way we do business. These changes came about through the reliable, fast, cheap, and quality digital services aimed at eliminating the most inefficient and risky elements of each sector. A number of technologies applied to legal products and services have been developed and used over time. Nevertheless, until the recent past, contracts establishing legal connections between parties were made physically. Increasingly, however, the preparation and enforcement of contracts, one of the most essential legal products/services, is being carried out on digital platforms.
Digital contracts were created for purchases made through websites and are executed through a reliable third-party tool. Such technological development has brought with it social and commercial developments; commercial relations have expanded, diversified, and become more complicated than ever before. The importance of smart contracts, a part of blockchain technology, is their potential to provide the speed and confidence required in commercial and social life.
Nick Szabo, who first used the term “smart contract”, defines them as a “promise system in which the parties also fulfill their commitments”. In order to understand how smart contracts work, this article examines the working principles and technological possibilities of blockchain technology, which enables the system to operate. In addition, the article examines the basic conditions of the establishment and validity of contracts within the existing legal structure and legal concepts and whether smart contracts fulfill these principles.
II. BLOCKCHAIN TECHNOLOGY AND SMART CONTRACTS
A. Blockchain technology
Blockchain technology is a record that registers the data in encrypted form, which is not kept by a central organization and all information in encrypted form is shared with everyone involved in the system1. Although blockchain technology can be defined in many ways, this definition clearly covers the most basic features of blockchain. Accordingly, it is a record, or a ledger, where encrypted data is kept. The records are transactions made on the blockchain system. In a sense, a bank's log-in transfer transactions for each cryptocurrency to its users in the blockchain system (a blockchain user is called a “Node”), such as its customers' registration of money transfers. However, while bank customers' records are kept only by the banks, the records on the blockchain registry, i.e. each money transfer transaction made by Nodes, are stored in encrypted form on Nodes’ computers, not by a single institution/organization.
Blockchain technology is not an international internet company such as Google, Facebook etc, but a database. Accordingly, blockchain technology, which came to the fore as a result of the discovery of Bitcoin cryptocurrency in 2009, is actually a continuation of the historical development of the internet. Before the use of the TCP/ IP protocol (transmission control protocol/ internet protocol), which began in 1972, data transfers could only be carried out online via pre-installed machines on both sides, allowing TCP/IP data to be digitized and divided into small pieces, or packets. It began to be used mainly for emailing. Since the late 1980s, large companies have begun to create local private net works using TCP/IP, and in the mid-1990s with the advent of the internet (World Wide Web), TCP/IP began to be used publicly. This facilitated the public exchange of information2. While the internet offers a protocol that provides the exchange of information, blockchain offers a protocol that provides value/money/property exchange3. As information exchange has become easier with the creation of technology companies as the internet grew, the exchange of value (money) with Bitcoin using blockchain technology by-passing the need for financial institutions has become possible.
The blockchain system has five (5) basic principles: (i) a distributed database, (ii) peer-to-peer transmission, (iii) anonymous transparency, (iv) unchangeable records, and (v) numerical logic.
The blockchain system is a distributed database. The feature that distinguishes this database from others is that data and transaction history are gathered centrally in traditional databases, while in the blockchain system they are stored in the computers of all users of the database.
The blockchain system is a distributed database. The feature that distinguishes this database from others is that data and transaction history are gathered centrally in traditional databases, while in the blockchain system they are stored in the computers of all users of the database. Thus, the need for a central authority collecting the data disappears: everyone who joins the network connects with each other and the validity of each transaction is certified by everyone4. In addition, although each transaction made over the blockchain system can be seen by all Nodes in the system, alphanumeric addresses above thirty characters of each Node allow transactions to be made in anonymous transparency5. However one of the most important features offered by blockchain technology is that, since a transaction made over the blockchain system is connected to the previous transaction, no records reaching the database and the addresses of the Node can be changed6. Finally, thanks to the digital nature of the blockchain database, the processes in the blockchain operate with a numerical logic, so they are able to create algorithms and rules that automatically trigger transactions between the Nodes. Thus, dependency on a central authority is eliminated and autonomous applications can develop, increasing the speed, efficiency, cheapness, and reliability of the transactions in practical life.
The transactions between the blockchain system parties are grouped together with other transactions and written to digital blocks using a code called “hash”. The hash code of each block is unique and each block contains the hash code of the previous blocks7. These blocks are added end to end to create a chain. The system ensures that these blockchains are reliably stored on the computers of the transaction parties and all users in the blockchain database. Consensus protocols ensure consistency between the records registered in the blockchain registry.
Consensus is established when the protocol is sure that each Node is adding the same new block to its records (local blockchain). Actors also update their registers by following these predetermined rules8. The most used protocol (including Bitcoin and Ethereum) is the proof-of-work protocol. According to this protocol, transactions approved by 51% of Nodes are considered valid. However, electricity consumption is increasing since each of the Nodes registered in the record must register the new block to the computer in order to access the aforementioned rate. In addition, due to this approval process, it takes a long time to record transactions in the blockchain database. Due to these technological disadvantages, alternative protocols have been developed9.
B. Smart contracts
The term "smart contract" was first used by Nick Szabo in 1994 and is the “computer processing protocol executing the terms of the contract”10. Smart contracts are self-enforceable/executable legal contracts created on digital platforms. In other words, contract terms and conditions are embedded in the code of the smart contract. Smart contracts are managed by computer programs on the blockchain infrastructure11. The first smart contract system was created by Ethereum. The technical operation of this system is the creation of smart contracts as computer codes and storage on Ethereum blockchain12.Due to using the blockchain infrastructure, all of the possibilities of that infrastructure – being unchangeable, decentralized, intermediary, peer-to-peer, processing in a certain numerical logic, and being in anonymous transparency – are possible for smart contracts.
The life cycle of a smart contract consists of four (4) stages: creation, freezing, execution, and finalization13. In the “creation” phase, the agreement the parties negotiate regarding the terms and conditions, as they do in classical contracts, is written in the code. Then, in the "freezing" phase, the code containing the terms and conditions is added to the chain in accordance with the consensus protocol. This stage is actually the time it takes for the Nodes to confirm the relevant code (transaction), which is the working principle of the blockchain system. In the "execution" stage, the contract is executed according to the agreement written in the code, and the transaction in completed in the "finalization" stage when they are confirmed as new data in accordance with the relevant consensus protocol and the records are stored in public14.
Smart contracts differ from conventional contracts in terms of being autonomous. Thanks to the autonomous execution of smart contracts, transactions (i) do not have to be done based on trust of a person or an institution, (ii) transaction costs decrease, (iii) counterparty risk, and (iv) uncertainty due to interpretation decreases15. The fact that the transactions do not have to be done through a person or institution is due to not being able to change blockchain technology; transactions can be made thanks to reliable technology instead of a particular reliable tool. Transaction costs are also reduced due to there being no need for an intermediary or follow-up due to the autonomous execution of the transactions. Thanks to their autonomous execution, smart contracts ensure that parties who do not know each other can trade with each other. This is because the execution of a provision written in the smart contract code is not technologically possible if a new code is not established by agreeing to stop the execution of the relevant provision of both parties. This autonomous situation eliminates the risk of the other party not fulfilling its obligations. Finally, since smart contracts are not, as in conventional contracts, enforced based on the interpretation of the parties, any uncertainty regarding obligations disappears and the agreement reached by the parties is applied exactly.
Since smart contracts are artificial intelligence, they cannot understand natural language and cannot confirm whether an event required to be executed has actually taken place. For this reason, “oracles” are needed. Oracles, either a software program or human, act as a bridge between the real world and the blockchain when there is not enough machine intelligence16. For example, information on whether the shipment of goods required for payment has taken place or whether interest rates are increasing year by year is transferred to the system by the oracle.
Despite the many advantages and possibilities of smart contracts, there are some shortcomings and weak areas. The weak areas include: (i) the non-modifiable and (ii) non-interpretable code, (ii) they are carried out in anonymous transparency, (iii) confidentiality of smart contracts is not fully ensured, and (iv) it is possible for smart contracts to be used for illegal transactions17. Firstly, due to the blockchain technology, the fact that the code and therefore the terms and conditions within it cannot be changed, as smart contracts are processed into blocks, means that it is impossible to change the terms and conditions of a smart contract should the parties wish to do so. In addition, abstract concepts (for example, goodwill, reasonable demands, diligence), whose content needs to be understood according to each concrete event, cannot be implemented by smart contracts. Since smart contracts are built on the blockchain infrastructure, each transaction is processed into the distributed registry and all Nodes are able to see each transaction. Although these transactions appear under usernames, this may not provide sufficient confidentiality. Finally, since smart contracts can be made without any intermediaries, unlawful (e.g. gambling debt) exchanges/borrowings, money transfers can be carried out with these contracts18. These points are the particular technical weaknesses of smart contracts and need to be taken into consideration when using them.
Other factors determining a user’s trust for smart contracts within Turkish law are whether smart contracts fulfill the terms of a legal contract, whether smart contracts (and the rights and obligations arising from these contracts) can be proved, and whether smart contracts can be upheld against a violating party where a contract is breached.
III. THE TERMS OF ESTABLISHMENT AND VALIDITY OF A CONTRACT IN TURKISH LAW
A. In General
Obligations arising from contracts, other obligations within the law especially of individuals, and the freedom of contract are recognized in the 48th amendment of the Constitution19 and, more specifically, in the TBK.19 According to the first paragraph of the TBK, a contract is defined as the parties involved in legal proceedings formed by a declaration of will that is mutual and conforming. As can be understood from this, there are certain conditions for the existence of a contract. These conditions are: involving at least two people and a mutual and appropriate expression of their will20.
B. Establishment of a Contract
The declarations of will required for the establishment of a contract is sorted according to their qualifications. As a result of this sorting process, different obligations and rights are granted to the declarers, so it is important that the declarations are classified as recommendations or acceptances21. If the above-mentioned elements (constituent elements) do not exist, there is no existing contract in the rule of law; in other words, there is an absence. Although there is no definitive indication of time in determining a proposal, it is generally considered that the declaration of the will of commitment, declared prior to determining a proposal, is a proposal22. This acceptance means that a contract should be made in accordance with the proposal.
Whether the declerations fit together or not is also important for the establishment of a contract. As a matter of fact, while no problem exists when there is mutual agreement on the statements, an issue does arise when the statements are appropriate but in the absence of consensus on the content of the statements, and that needs to be examined23. Whether the will of the parties is intended for the establishment of the contract and the issues agreed on what issues the parties agree on if the contract is established, the principle of trust can be determined by taking into account. According to the will of the parties interpretation of the declaration of TBK 2, “If the parties are numb at the fundamental points of the contract, even if the second-degree points are not discussed, the contract shall be deemed to have been established”.
C. Requirements for Express Terms in Contracts (Validity Conditions)
1. General Terms
Some requirements for validity of an agreement apply to all contracts and some only to certain contracts. The parties must have the power to distinguish (TMK m. 15), the subject of the contract should not be impossible, as per TBK Art. 27, and should not be contrary to the provisions, morality, public order, and personal rights, and declarations of will should not be crippled24 or defective for various reasons.
2. Freedom of Form
One of the most important conditions is the freedom of form. As a matter of fact, TBK Art. 12/I says that “the validity of contracts is not bound by any form unless otherwise predicted in the law”, and that, as a rule, contracts are not bound by form. An exception to this rule is that a form requirement is imposed for specific contract types or subjects. Although the benefits and disadvantages of being subject to the form condition of a contract are discussed in the teaching25, the fact that the legislator recognizes such a broad freedom means that this freedom is attributed particular importance.
The existence of the above-mentioned conditions are sufficient for a contract that is not conditioned by the law to be valid. In this case, the arrival at an acceptance decleration in response to a valid proposal, the compliance of those declarations, and the fact that the parties have the power to distinguish apply to this agreement. The most important thing among the complementary elements of contractual freedom, which is one of the foundations on which the TBK is based, is the freedom of form and the matching of wills.
IV. ESTABLISHINGAND PROVISIONING SMART CONTRACTS ACCORDING TO TURKISH LAW
Since there is, as yet, no specific legislation regarding the establishment and provision of smart contracts, it is necessary to consider the general provisions concerning the establishment and provision of contracts under Turkish law.
A. Establishment of Smart Contracts
In order to establish a smart contract, an offer and acceptance is required, just as in conventional contracts, and the declarations are expected to match. As described above, the establishment of smart contracts takes four (4) stages. In the “creation” phase of a smart contract, the parties agree on mutual negotiations, just as they do in conventional contracts. However, “there will be contracts between people who are not ready because the parties will not be present as a rule, and therefore the issues of the matter with which the benefit will be made in the nature of the declaration of will and the arrival of the other party will need to be examined”26.
As soon as the Nodes confirm their declaration with their private key, the declaration of will is deemed to have been made and a smart contract will have been established27.
B. Provision of Smart Contracts (Validity)
In the “freeze” phase after the “creation” phase, the blockchain system requires that the relevant block be added to the block chain, after the parties approve a transaction with their private keys, and that it is certified by other Nodes, so “it is necessary to distin - guish between the declaration of will, the establishment of the contract, and the stag - es of the contract's sentencing”28. Nodes can be deemed to have made a declaration of will as soon as they approve their decla - rations with a private key, while the smart contract is deemed established at the time of the formation of the new block29. At this point, however, if the block, which includes the smart contract code, is not approved by 51% of Nodes, there will be a situation where the block does not form and connect to the blockchain, and the smart contract that the parties wish to establish with declarations of will may be void30. It should be noted that 51% of all Nodes are searched in the proofof-work protocol. In this respect, it is possible to use private blockchains rather than public blockchains or that the weaknesses associated with new protocols already under development can be overcome in the future.
The work of establishing and sentencing smart contracts is part iv of this article. The “creation” and “freezing” are important phases listed under heading A: the steps of the implementation of the provisions and con - ditions in smart contracts will be important.
Through smart contracts, all contracts can be made under the freedom of form in Turk - ish law, except for the types of contracts that are not specifically conditioned by the form. Smart contracts will need to meet the requirements under the regulatory princi - ples, particularly TMK and TBK, regarding the provision of provisions.
a. Presence of Rights and Verb Licenses of Smart Contract holders
First, it should be noted that the actions of those who do not have the power to distin - guish as a rule are the 15th century of the TMK. shall not produce legal consequences in accordance with article 10. Similarly, mi - nors and constrained with the power to dis - tinguish are not able to conduct their own transactions to borrow without the consent of a legal representatives. Accordingly, in order to establish a contract, the parties will need to meet these conditions. However, if the blockchain site is trading with Nodes’ usernames (with their own numbers) and these usernames can be obtained without the approval of any intermediary regardless of the Nodes’ legal personality, it is import - ant to determine the existence of rights and verb licenses at the point of signing and borrowing the relevant smart contract. In fact, if the contract parties do not have the rights and verb license, the contract may be void, as encountered in conventional contracts. However, the reason this issue is important in terms of smart contracts is that smart contracts are made between parties that do not know each other at all and con - duct the contract through blockchain tech - nology (without any need for reliable inter - mediaries) and therefore there is a risk that a smart contract will be voided due to the lack of rights or verb licenses of the parties. It should be noted that in such a situation, be - cause smart contracts are autonomously ex - ecutable contracts, it is difficult to enforce the consequences in a case of inability to perform the obligations of a smart contract, resulting in a deterioration of the flow of commercial life. In terms of Turkish law, in the event of such a lack of license, the smart contract will be void. To avoid this, the bridge between the blockchain system and real life will prevent unlicensed persons from signing a smart contract by or - dering a check of the parties’ rights and verb licenses.
b. The Subject of Smart Contracts Is Not Impossible and Violates The Imperative Provisions, Ethics, Public Order, and Personality Rights
The subject of smart contracts should not be impossible as counted in TBK Art. 27 and should not be contrary to the provisions, mo - rality, public order, and personal rights. These situations can also be blocked by ora - cles. However, the fact that smart contracts that constitute a violation of orderly provisions, morality, and public order, the autonomous execution/performance of smart contracts that cannot be stopped, can cause damage of the values that are legally protected.
c. Restricted Will of Smart Contract Parties
It is useful to examine the validity of smart contracts so that the parties’ declarations of will are not restricted. In the doctrine, the right of one contract party to request the cancellation of a contract in the block - chain system in case of error, deception, or intimidation is restricted if the will of one of the parties to the contract is contradicted by the principle of non-change of transactions31. However, it should be noted that if the parties to a smart contract have to suf - fer from will-be, the issue may be referred to the dispute resolution authorities. Prov - ing that the party’s will has been restrict - ed is the responsibility of the party that claims that their will is restricted, just as in conventional contracts. As a result, a new smart contract can be created and added to the block so that the terms and conditions of the relevant smart agreement are in accordance with the relevant authority's decision. In this respect, the original smart contract is not changed, but by amending a new one, the autonomous performances under the cancelled contract can be reversed. Oracles are able to implement the decisions of dispute resolution authorities in the blockchain system32.
V. CONCLUSION
Due to the way the blockchain technology used by these contracts works, the decision of parties to establish smart contracts on which their will is written in computer code takes place at different times. Therefore, the rights and obligations under the smart contract shall be frozen during the period between the provision being expressed and the contract being established. By writing the relevant smart contract to the block, the contract becomes part of the blockchain network. In other words, the obligations set out in the smart contract will now be performed in accordance with its the terms and conditions.
A legal framework for the enforcement and validity of smart contracts has yet to be established. For this reason, the current legal arguments regarding the validity and enforcement of smart contracts are given according to the general law under the TBK and TMK .
Since blockchain technology is not dependent on a central intermediary, it is carried out as required by the smart contracts produced with this technology, i.e. to ensure that the parties fully meet their obligations. It is essential that the resources this technology uses is reliable and that the parties trust that technology. In addition, a serious concern in the execution of a contract within the general rule of law is how it is possible to suspend a contract were that requested, considering that smart contracts are unchangeable, autonomous contracts.
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FOOTNOTE
1 Mesut Serdar Çekin, “Borçlar Hukuku ile Veri Koruma Hukuku Açısından Blockchain Teknolojisi ve Akıllı Sözleşmeler: Hukuk Düzenimizde Bir Paradigma Değişimine Gerek Var Mı?”, İstanbul Hukuk Mecmuası, İstanbul, June 2019, p.323
2 Marco Iansiti and Karim R. Lakhani, “The Truth About Blockchain”, Harvard Business Review, January-Februrary 2017: https://hbr. org/2017/01/the-truth-about-blockchain?referral=03758&cm_vc=rr_ item_page.top_right (Date of access, 08.03.2020)
3 Michele Finck, Blockchain Regulation and Governance in Europe, 1st Edition, Munich 2019, p.10
4 Çekin p.320
5 Iansiti/Lakhani
6 Iansiti/Lakhani
7 Cardozo Blockchain Project. (2018). Smart Contracts & Legal Enforceability. Research Report#2. p.2
8 Finck, p.21
9 Finck, p.21
10 Nick Szabo, “Smart Contracts”, 1994: http://www.fon.hum.uva.nl/ rob/Courses/InformationInSpeech/ CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/ smart.contracts.html (Date of access: 08.03.2020)
11 Ezgi Elife Pilavcı, “The Regulation of Smart Contracts: Law, Governance and Practice”, İstanbul Bilgi Üniversitesi Lisansüstü Programlar Enstitüsü Bilişim ve Teknoloji Hukuku Yüksek Lisans Programı, İstanbul 2019, p.4
12 Pilavcı p.5
13 Finck, p.26
14 Finck, p.26
15 Finck, p.25
16 Finck, p.25
17 Primavera De Filippi ve Aaron Wright, Blockchain and the Law: The Rule of Code, 3rd Edition, 2018, p.83
18 Filippi/Wright p.86
19 Kemal Oğuzman/Turgut Öz, General Provisions of the Obligations Law, Volume 1, Istanbul 2018, p. 24
20 Ahmet Kılıçoğlu, General Provisions of the Law on Obligations, Ankara 2019, p. 84
21 Kılıçoğlu p.84
22 Oğuzman/Öz p.50; Kılıçoğlu p.84
23 Oğuzman/Öz p.69
24 Oğuzman/Öz p.90
25 Oğuzman/Öz p.140; Kılıçoğlu p.144
26 Çekin p. 325
27 Çekin p. 326
28 Çekin p. 325
29 Çekin p. 326
30 Çekin s. 326
31 Çekin p.327
32 Filippi/Wright p.85
