Mapping Ai-Arbitration Landscape: Exploring Blockchain Based Arbitration Models Through A Legal Lens

Update: 2024-06-05 07:45 GMT
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In today's time, blockchain technology stands to be extremely revolutionary in every aspect of life. Its decentralized structure, immutable record keeping and operation on a peer-to-peer computer network, makes it a transparent and trustworthy asset.i This technology finds its place in smart contracts which simply connote contracts that are self-executing based on performance of...

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In today's time, blockchain technology stands to be extremely revolutionary in every aspect of life. Its decentralized structure, immutable record keeping and operation on a peer-to-peer computer network, makes it a transparent and trustworthy asset.i This technology finds its place in smart contracts which simply connote contracts that are self-executing based on performance of certain actions already fed via code.ii

Smart contracts when run over blockchain technology conceptualize the idea of blockchain- based Arbitrations. One can imagine a situation wherein two parties come into a contract for the buying and selling of commodities at a set price. This contract houses an arbitration clause which shall only be invoked by the parties in case of a dispute. Therefore, assuming if this was based on blockchain-based smart contracts, non-payment of the set price, or incomplete payment and non-delivery of commodities would trigger the arbitration clause.

Blockchain based arbitration classifies further into two types, based off the stage of arbitration at which blockchain is deployed, these are –

'On-chain' Arbitration – It refers to the use of blockchain based smart contracts for the automatic execution of the 'arbitral award' eliminating traditional court interference for enforcement of the said award.iii For instance, smart contract is coded to release a particular amount to the party in favor of whom the award will be passed.

'Off-chain' Arbitration – It refers to the automation of certain elements of an Arbitration rather than the entire process and there is no automatic execution of award that may be present under this scenario.iv For example, use of blockchain for appointment of arbitrators in a traditional arbitration set-up.

Theoretically, blockchain based Arbitration systems seem like the 'perfect solution', however, it comes with its own challenges. Through this article, we discuss the existing blockchain based arbitration model i.e. Kleros and its working. Further, we assess the feasibility of these systems on parameters such as Legal compliances, Party Autonomy, Confidentiality and Award enforcement.

Case study – Kleros model

Kleros has come into limelight since a Mexican court has upheld the arbitral award that was passed by it.v Incepted in the year 2017, Kleros serves to be a decentralized dispute resolution mechanism for contractual disputes.vi Kleros itself uses a hypothetical explanatory dispute between Alice and Bob ( hereinafter referred to as “disputants”) to help the audience grasp the concept of kleros, wherein Bob is supposed to make a website for Alice and she will pay him based on his work.vii However, Alice is dissatisfied with the website and refuses to pay the same. This is a typical dispute which could be resolved via kleros.

The disputants in the instant case, can either register their transaction on the Kleros Escrow DAppviii (decentralized platform built over Ethereum network for facilitation of transfer of goods) and opt for Kleros as the dispute resolution mechanism in their smart contracts or may also proceed via non-smart contracts set-up but would not be able to avail automatic enforcement of the award so given.ix The contract funds under dispute is further stored in a kleros controlled escrow account.x

Irrespectively, for registration of every crypto transaction in the Escrow DApp a fee called 'gas' is charged.xi The Escrow DApp registers the parties' transaction type, contract amount, time of when the funds become due and Ethereum Network address for due perusal.xii Based off which the parties are prompted to answer if the compliance with the contract has been done. If the answer is yes, contract fund would be released in favor of the party to whom it is payable. If not, then arbitration would be invoked.

This would now require parties to pay arbitrators' fee and gas fee which would again be stored. This payment is mandatory for both the parties because non-payment as per deadline would lead to a direct loss of dispute by the party in question. Further, the winning party would be reimbursed their arbitration fee as well as the contract fund and it is only the losing party on whose end the arbitration fee would be paid to the coherent jurors.xiii

To be a juror, anyone in the world could participate by purchasing Pinakion (PNK) which is kleros personal crypto token, and a certain amount is to be pledged in one of kleros' courts as 'entry fees'.xiv The amount staked decides chances of being selected as a juror. Therefore, higher the stake, higher the chances of being part of the 'arbitral tribunal'. Only coherent Jurors who partook in the majority would be paid the arbitration fees.xv Refraining from voting and incoherently voting would not reap any economic incentive for such jurors. To further curtail such incoherency, an extra expense in the form of penalty wherein they lose their PNK tokens is imposed.

This entire system also has an appeal system which allows the dissatisfied party to appeal the award, however, the only change being that the number of jurors would be doubled each time. Therefore, the arbitration fees would also increase, hence causing a deterrent effect on the parties.xvi

Based off the Kleros system, one can understand that there exists both positives and negatives to its usage. Skepticism and lack of awareness associated with the system cater to the limited user adoption. As per the latest statistics, a total of 1640 cases have been referred over Kleros and 199,583,691 PNK has been staked.xvii Despite being ever-growing, a mass adoption has not been noticed due to the potential risks associated with the system.

Legal perspective

To understand the viability of Kleros like Blockchain based Arbitration systems, feasibility in terms of user adoption and accuracy is not enough. One can use the following parameters to understand its legal implications and usages as a replacement or supplement to the traditional arbitration regime-

Legal Compliance – For any Blockchain based Arbitration system to be successful, the award so passed should be legally compliant with the established procedural requirements and enforceable by law. Procedurally, the instant blockchain based Arbitration models fail to comply with the set standard. For instance, the Indian Arbitration and Conciliation Act, 1996 (“Arbitration Act, 1996”) through section 7 requires an arbitration agreement to be 'written'. However, one cannot equate a smart contract that is software coded to a written arbitration Agreement. This makes the validity of the arbitration agreement extremely questionable. The IT Act, 2000 has come to the rescue with recognition of contracts formed via 'electronic means', proceedings initiated prior to such amendment would still be excluded.xviii While this is just an instance of India, this is a cross jurisdictional issue. The same argument stems towards the arbitrability of disputes as well. What might be arbitrable in one jurisdiction may not be recognized in another. For example, the Shenzhen Intermediate People's Court had set aside an arbitral award passed by Shenzhen Arbitration Commission as the damages awarded were in lieu of cryptocurrency which is still considered against public interest as opposed to fiat money in China.xix While On-chain arbitrations may not face this issue, off-chain arbitrations may simply be counterproductive if there is no compliance with the governing law as well as the law of the place where enforcement is sought. The situation becomes even more complex when both the laws are completely antagonistic.

Party Autonomy – Essentially, Arbitration supports the principle of Party Autonomy which means that parties are in major control of the arbitration proceedings. However, with Blockchain arbitrations, this party autonomy withers away. Taking the example of Kleros, there is random selection of arbitrators based on their stakes. This disallows the parties from making informed choices in selecting their arbitrators further taking away the credibility of the selected persons. Virtually anyone, including non-experienced persons can become arbitrators simply based on their stakes. This deters the party from trusting dispute resolution to anonymous persons. Similarly, party autonomy is also impacted when smart contracts virtually remove the room for other alternative dispute resolution mechanisms like mediation. The self-executing nature of smart contracts take away the freedom to explore other possible amicable resolution mechanisms that could be far more beneficial to the parties.xx This reduces flexibility in an on-chain arbitration making it a less feasible option for parties.

Confidentiality – With people increasingly preferring arbitrations, the element of confidentiality is an added advantage. However, if an arbitration is done on a public blockchain, then the permissionless system allows for its access to everyone. This would mean that arguments, documents and even evidence would be open to everyone other than the parties which would ultimately be synonymous to an open court.xxi Ultimately, such blockchain arbitrations may not be the first choice of parties. On the Contrary, Kleros is based on a private blockchain which maintains confidentiality and provides access to the materials only to the arbitrators/jurors and parties in question. Therefore, making it a considerable option in this aspect.xxii

Award enforcement – Lastly, Blockchain arbitrations have their own challenges when it comes to award enforcement before courts. Since it is only off-chain arbitrations which require the involvement of the traditional courts, it is imperative that they comply with the legal procedures set. Taking a specific example of Indian law, Section 31 lays down the form and contents of an arbitral award. It essentially requires a written arbitral award to be signed with specific mention of the date and place of Arbitration. This requirement remains unfulfilled as blockchain arbitrations are completely decentralized and virtual hence no seat can be mentioned.xxiii Moreover, the jurors' identity are anonymous, therefore the award cannot be signed. Lastly, for a domestic award the arbitral award that is required to be enforced should be stamped.xxiv However, when there exists no written award, stamping it is yet another challenge.

Suggestions

A progressing society directly implies technological advancement. With that being said it is also time that laws become equally accommodative of this advancement. With specific reference to blockchain Arbitration, a mutual attempt is required such that both i.e. the Arbitration blockchain model as well as the law can accommodate the requirements of each other. While this might not be possible in one go, advancing technology can help reach a realistic solution to replace traditional arbitrations with Blockchain arbitrations.

It is further acknowledged that Blockchain Arbitrations are still under exploration. Therefore, a full transition to on-chain arbitrations may not be feasible but off-chain arbitrations with integration of specific elements of blockchain to the traditional Arbitration system might still be helpful in the present world.

Lastly, systems like Kleros depict that the society is getting ready to transition to an unconventional yet convenient dispute resolution mechanism. Jur and Argon are some other instances of Blockchain Arbitration mechanisms that have been made. It is time that international organizations would start recognizing such mechanisms legally and providing it with the legitimacy it requires for an easy transition.

Views are personal.

i Primavera De Filippi & Samer Hassan, Blockchain Technology as a Regulatory Technology: From Code is Law to Law is Code, FIRST MONDAY pg. 21 (2016), https://firstmonday.org/ojs/index.php/fm/article/view/7113/5657

ii Id. at Pg. 74

iii Katarzyna Szczudlik, “On-chain” and “off-chain” arbitration: Using smart contracts to amicably resolve disputes, NEWTECH.LAW (Feb. 25, 2024, 10:04 AM), https://newtech.law/en/on-chain-and-off-chain-arbitration-using-smart-contracts-to-amicably- resolve-disputes/

iv Id.

v Maxime Chevalier, Arbitration Tech Toolbox: Is a Mexican Court Decision the First Stone to Bridging the Blockchain Arbitral Order with National Legal Orders?, KLUWER ARBITRATION BLOG (Feb. 25, 2024, 10:04 AM),

https://arbitrationblog.kluwerarbitration.com/2022/03/04/arbitration-tech-toolbox-is-a- mexican-court-decision-the-first-stone-to-bridging-the-blockchain-arbitral-order-with- national-legal-orders/

vi Luis Bergolla, Karen Seif and Can Eken, Kleros: A Socio-Legal Case Study Of Decentralized Justice & Blockchain Arbitration, Vol. 37:1 Ohio State Journal on Dispute resolution.1, 20-21 (2022) https://moritzlaw.osu.edu/sites/default/files/2022-08/10-%20BERGOLLA%2055- 98.pdf

vii Stuart James, 3 Things to Know About Becoming a Kleros Juror, KLEROS (Feb. 28, 2024, 10:00 AM), https://blog.kleros.io/become-a-juror-blockchain-dispute-resolution-on- ethereum/

viii Stuart James, Kleros Escrow Explainer - Secure Your Blockchain Transactions Today, KLEROS (Feb. 28, 2024, 10:00 AM), https://blog.kleros.io/kleros-escrow-secure-your- blockchain-transactions-today/

ix Supra vi at Pg. 7

x Supra viii

xi Gas and Fees, ETHEREUM (Sept. 7, 2021), https://ethereum.org/en/developers/docs/gas/.

xii Supra vi at Pg. 9

xiii Supra vi at Pg. 10

xiv James Metzger, The Current Landscape of Blockchain-Based, Crowdsourced Arbitration, 19 MACQUARIE L.J. 81, 99 (2019)

xv Supra viii

xvi Joe Tirado and Gabriela Cosio, Lex Cryptographia: Guidelines for ensuring due process in transnational blockchain-based arbitration [1], INTERNATIONAL BAR ASSOCIATION (Feb. 28, 2024, 1:00 PM) https://www.ibanet.org/lex-cryptographia-due-process-blockchain- based-arbitration

xvii KLEROS, https://klerosboard.com/1, (last visited Feb. 28, 2024, 10:00 AM)

xviii Ritika Bansal, Enforceability of Awards from Blockchain Arbitrations in India, KLUWER ARBITRATION BLOG (Feb. 25, 2024, 10:04 AM),

https://arbitrationblog.kluwerarbitration.com/2019/08/21/enforceability-of-awards-from- blockchain-arbitrations-in-india/

xix Helen Tang, Antony Crockett and Briana Young, PRC COURT SETS ASIDE CRYPTOCURRENCY AWARD ON PUBLIC INTEREST GROUNDS, HERBERT SMITH

FREEHILS (Feb. 27, 2024, 12:04 PM) https://hsfnotes.com/arbitration/tag/setting- aside/#:~:text=The%20Shenzhen%20Court%20ruled%20that,set%20aside%20the%20arbitra l%20award.


xx Rana Sajjad Ahmad, Blockchain Arbitration: Promises and Perils, The American Review of International Arbitration (Feb. 27, 2024, 12:04 PM) https://aria.law.columbia.edu/blockchain- arbitration-promises-and-perils/

xxi Id.

xxii https://ipfs.kleros.io/ipfs/QmW81Rff1ePQ7VuwcnRwARdGce52qbX77kur55Xju3jnSx xxiii Raghav Saha and Harshit Upadhyay, Blockchain Arbitration in India: Adopting the Hybrid Model Envisaged by Mexican 'Kleros' Case, INDIA CORP LAW (Feb. 27, 2024, 12:04 PM) https://indiacorplaw.in/2022/06/blockchain-arbitration-in-india-adopting-the-hybrid-model- envisaged-by-mexican-kleros- case.html#:~:text=In%20its%20essence%2C%20blockchain%20arbitration,%2C%20better% 20document%20management%2C%20etc.

xxiv Supra xviii


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