Mitigating the Legal Challenges Associated with Blockchain Smart

Washington and Lee Law Review Washington and Lee Law Review

Volume 80 Issue 3 Article 6

Summer 2023

Mitigating the Legal Challenges Associated with Blockchain Mitigating the Legal Challenges Associated with Blockchain

Smart Contracts: The Potential of Hybrid On-Chain/Off-Chain Smart Contracts: The Potential of Hybrid On-Chain/Off-Chain

Contracts Contracts

Niloufer Selvadurai

Macquarie University

, niloufer[email protected]

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Recommended Citation Recommended Citation

Niloufer Selvadurai,

Mitigating the Legal Challenges Associated with Blockchain Smart

Contracts: The Potential of Hybrid On-Chain/Off-Chain Contracts

, 80 Wash. & Lee L. Rev. 1163

(2023).

Available at: https://scholarlycommons.law.wlu.edu/wlulr/vol80/iss3/6

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

1163

Mitigating the Legal Challenges

Associated with Blockchain Smart

Contracts: The Potential of Hybrid

On-Chain/Off-Chain Contracts

Niloufer Selvadurai

Abstract

Tantamount with the increasing application of blockchain

technologies around the world, the use of blockchain-based smart

contracts has rapidly risen. In a “smart contract,” computer

protocols automatically facilitate, verify, and enforce

arrangements made between parties on a blockchain. Such smart

contracts offer a variety of commercial benefits, notably

immutability and increased efficiency facilitated by removing the

need for a trusted intermediary. However, as discussed in recent

legal scholarship, it is difficult for smart contracts to uphold

certain fundamental principles of contract law. Translating

concepts of individual intention and responsibility into the

decentralized space of blockchain is problematic. Aggregating

such individual intention into the combined will and intention

of the blockchain entity is at best challenging, and at worst

unfeasible. Further, while traditional contracts accommodate

change and allow for the amendment of terms in response to

evolving circumstances, blockchain smart contracts do not. As

the difficulties of blockchain smart contracts become apparent,

attention is turning to hybrid smart contracts.

* Professor Niloufer Selvadurai, BA LLB (Hons I) USyd, PhD Mq,

Director of Research & Innovation, Macquarie Law School, Macquarie

University, Sydney, Australia.

1164 80 WASH. & LEE L. REV. 1163 (2023)

“Hybrid” smart contracts are commonly described in legal

discourse as arrangements that consist of both a traditional

contract (natural language) and a blockchain-based smart

contract (formal computer code) component. In comparison,

computer science scholarship provides a more complex and

nuanced articulation, framing hybrid smart contracts as

arrangements that combine code running inside the blockchain

(on-chain) with data and computations from outside the

blockchain (off-chain). The link between these on-chain and

off-chain operations is created through a decentralized oracle

network. Such hybrid contracts maintain the immutability of

blockchain, and the trustless contracting this facilitates, with the

flexibility that comes from connecting to real-world, real-time

data sources.

In such a context, the objective of this Essay is to examine

the nature and operation of hybrid smart contracts, integrating

both legal and computer science discourse, and to critically

analyze whether such arrangements have the potential to

mitigate some of the legal challenges that have been identified

with respect to fully on-chain smart contracts.

Table of Contents

NTRODUCTION ................................................................ 1165

I. T

HE NATURE AND OPERATION OF SMART CONTRACTS

............................................................................... 1169

A. Phases of Creation .......................................... 1169

B. Means of Verification ...................................... 1170

C. Immutability .................................................. 1170

II. L

EGAL AND TECHNICAL ARTICULATIONS OF HYBRID

SMART CONTRACTS ................................................ 1171

A. The Legal Discourse ........................................ 1171

B. Technical Framings ........................................ 1173

III. T

HE CAPACITY OF HYBRID SMART CONTRACTS TO

MITIGATE LEGAL CONCERNS ASSOCIATED WITH

SMART CONTRACTS ................................................ 1174

A. Formation—Greater Certainty ....................... 1174

B. Interpretation—Greater Clarity ..................... 1175

C. Performance – Greater Flexibility .................. 1177

MITIGATING THE LEGAL CHALLENGES ASSOCIATED

WITH BLOCKCHAIN SMART CONTRACTS 1165

ONCLUSION .................................................................... 1179

NTRODUCTION

As blockchain technologies are increasingly deployed

around the world, reliance on blockchain-based smart contracts

has correspondingly risen.

A “smart contract” consists of

computer protocols that automatically facilitate, verify, and

enforce agreements made between parties on a blockchain,

based on a set of predetermined factors.

Agreements are

embedded in software code and automatically executed on the

blockchain, giving rise to the autonomous and self-executing

characteristics of smart contracts.

The commercial benefits of

smart contracts have been well-documented.

Smart contracts

can help the traditionally ponderous and slow machinery of

contract law keep pace with the far more rapid transactions

enabled by contemporary technologies.

Removing the need for

protracted negotiations between individuals, as well as

1. See SHUBHANI AGGARWAL ET AL., ADVANCES IN COMPUTERS: THE

BLOCKCHAIN TECHNOLOGY FOR SECURE AND SMART APPLICATIONS ACROSS

INDUSTRY VERTICALS 5 (Ali Hurson eds., 1st ed. 2021) (“Governments and

corporates all over [the] world are slowly and steadily realizing the value in

blockchain, which is a new kid on the block.”). “Blockchain” is one type of

distributed ledger technology (DLT) where transactions are recorded using

immutable cryptographic signatures. See What is Blockchain Technology?,

NT’L BUS. MACHS., https://perma.cc/62MS-JQV4. It refers to a distributed

database that maintains a ledger of records, termed “blocks,” which are linked

using cryptography. Id. If a particular user on a blockchain desires to perform

a transaction, the request is recorded on the ledger in a node and a copy is then

made available to all the users on that chain. Id. If the users verify the

transaction in the node and reach a consensus, the transaction is

authenticated. Id.

2. Shuai Wang et al., Blockchain-Enabled Smart Contracts:

Architecture, Applications, and Future Trends, 49

IEEE TRANSACTIONS ON SYS.,

MAN & CYBERNETICS: SYS. 2266, 2266 (2019).

3. Id.

4. See Somboun Tern, Survey of Smart Contract Technology and

Application Based on Blockchain, 11 O

PEN J. APPLIED SCIS. 1135, 1135 (2021)

(“[Contract technology] . . . is widely used in digital payment, financial asset

disposal, multi-signature contracts, cloud computing, Internet of Things,

sharing economy and other fields.”); Marco Iansiti & Karim R. Lakhani, The

Truth About Blockchain, H

ARV. BUS. REV., Jan.–Feb. 2017, at 7.

5. See infra Part III.

1166 80 WASH. & LEE L. REV. 1163 (2023)

removing the need for trusted intermediaries, increases

efficiency and facilitates the rapid formation of large-scale,

multi-party, multi-sector, multi-jurisdiction contracts.

The

automation of performance and enforcement advances efficiency

and reduces cost. However, as the operation of blockchain-based

smart contracts comes under greater legal scrutiny, concerns

are emerging about the extent to which they can uphold

established principles of contract law.

A contract is in essence

an agreement between identified individuals, reflective of their

unique will, wishes and intentions.

Translating this concept of

individual intention and responsibility into the decentralized

space of blockchain is problematic.

Aggregating such individual

intentions into a combined will and intention is also

challenging.

Further, while contractual principles allow for

negotiation and amendment of terms in response to evolving

circumstances, blockchain smart contracts do not support such

commercial agility.

The contractual doctrine of frustration

6. See Primavera De Filippi et al., Block Chain as a Confidence

Machine: The Problem of Trust & Challenges of Governance, T

ECH. SOC’Y, 2020,

at 1 (“Blockchain technology . . . has emerged as a potential solution to the

erosion of trust in traditional institutions and online intermediaries more

generally, as it allegedly eliminates the need for trust between parties.”).

7. See Joshua Fairfield & Niloufer Selvadurai, Governing the Interface

Between Natural and Formal Language in Smart Contracts, 27 UCLA

J.L. &

TECH. 79, 111–17 (2022) (discussing the issues that arise when applying

current contract law to smart contracts); Alexander Savelyev, Contract Law

2.0: ‘Smart’ Contracts as the Beginning of the End of Classic Contract Law, 26

NFO. & COMMC’NS TECH. L. 116, 128–33 (2017) (listing the issues and

challenges of “[s]mart contracts in the context of the present contract law”).

8. See generally Guido Governatori et al., On Legal Contracts,

Imperative and Declarative Smart Contracts, and Blockchain Systems, 26

RTIFICIAL INTEL. & L. 377 (2018).

9. See Gabriel Olivier Benjamin Jaccard, Smart Contracts and the Role

of Law, JUSLETTER IT, Nov. 2017, at 8 (Switz.) (“[A] computer code won’t take

into account the possible nullity of a legal contract unless taught to. Instead,

its system is based on its own norms and will execute the agreement according

to its given design only.”).

10. See Stuart D. Levi et al., An Introduction to Smart Contracts and

Their Potential and Inherent Limitations, H

ARV. L. SCH. F. ON CORP.

GOVERNANCE, (May 26, 2018), https://perma.cc/6V46-4DFH (“The objectivity

and automation required of smart contracts can run contrary to

how . . . parties actually negotiate agreements.”).

11. See id. (“[Parties] may determine that if an unanticipated event

actually occurs, they will figure out a resolution at that time. . . . This

approach to contracting is rendered more difficult with smart contracts where

MITIGATING THE LEGAL CHALLENGES ASSOCIATED

WITH BLOCKCHAIN SMART CONTRACTS 1167

enables obligations to be revised in light of external

circumstances outside the control of parties.

In marked

contrast, the immutability of blockchain platforms hinders such

nuanced response to circumstances.

Finally, it remains

unclear whether and to what extent blockchain-based smart

contracts can be enforced in courts and arbitration centers

around the world.

So, how can we harness the commercial potential of

blockchain-based smart contracts while also upholding

established principles of contract law which protect human

agency and wider societal interests? One option is to use hybrid

smart contracts. However, the notion of hybrid smart contracts

in legal and technical discourse displays some interesting

variances. Legal discourse typically defines a hybrid smart

contract as one in which some legal obligations are expressed in

natural language and others are expressed in the formal code of

a computer program.

In comparison, technical discourse

focuses on the capacity of hybrid smart contracts to combine

code running inside the blockchain (on-chain) with data and

computations from outside the blockchain (off-chain).

decentralized oracle network creates links between these

on-chain and off-chain operations.

Such hybrid contracts

maintain the immutability of blockchain, and the trustless

contracting this facilitates, with the flexibility that comes from

computer code demands an exactitude not found in the negotiation of

text-based contracts.”).

12. See R

ESTATEMENT (SECOND) OF CONTRACTS § 265 (AM. L. INST. 1981).

13. See supra note 11 and accompanying text.

14. See Jaccard, supra note 9, at 22.

15. See L

AW COMMISSION, SMART LEGAL CONTRACTS, ADVICE TO

GOVERNMENT, 2021, HL 401, at vi (UK), https://perma.cc/J9WU-3VPA (PDF)

(defining on-chain and off-chain).

16. See L

ORENZ BREIDENBACH ET AL., CHAINLINK 2.0: NEXT STEPS IN THE

EVOLUTION OF DECENTRALIZED ORACLE NETWORKS 2 (2021) (describing hybrid

smart contracts as “[o]ffering a powerful, general framework for augmenting

existing smart contract capabilities by securely composing on-chain and

off-chain computing resources”).

17. See id. at 6–7 (“[DONs] goal is to enable secure and flexible hybrid

smart contracts, which combine on-chain and off-chain computation with

connection to external resources.”).

1168 80 WASH. & LEE L. REV. 1163 (2023)

connecting to real-world, real-time data sources.

It is

suggested that in order to mitigate the legal problems associated

with fully on-chain smart contracts through the use of hybrid

smart contracts, it is necessary to bring together these legal and

technical understandings.

These understandings are not

inconsistent. Rather they differ in their focus and the varying

degrees of attention paid to contractual principles and logistics

of operation.

In such a context, the objective of the present paper is to

provide a preliminary exploration of the benefits of hybrid smart

contracts, integrating legal and technical discourse, and

consider whether such arrangements have the potential to

mitigate some of the legal challenges that have been identified

with fully on-chain smart contracts. There has been a

sophisticated discourse on the capacity of code to operate as

law,

and conversely, the ability of law to operate through

code.

This scholarship has been extended through a

18. See id.

19. See Joshua Gacutan & Niloufer Selvadurai, The Relevance of Internet

Architecture to Law: The Liability of Internet Service Providers for Harmful

User-Generated Content, 3 A

USTL. NAT’L U. J.L. & TECH. 55, 72–73 (2022) (“An

understanding of Internet structure is . . . critical . . . because, as discussed,

each layer of the Internet’s architecture has very different economic and

technological attributes.”).

20. See L

AWRENCE LESSIG, CODE AND OTHER LAWS OF CYBERSPACE 6 (1999)

(“[T]he argument of this book is that the invisible hand of cyberspace is

building an architecture . . . that perfects control—an architecture that makes

possible highly efficient regulation.”); Lawrence Lessig, Code Is Law: On

Liberty in Cyberspace, H

ARV. MAG., Jan. 1, 2000, https://perma.cc/3YB9-Q9VT.

For differing perspectives see Jan Oster, Code is Code and Law is Law—The

Law of Digitalization and the Digitalization of Law, 29 INT’L J.L. & INFO. TECH.

101, 101 (2021) (arguing for a “sharp analytical distinction between the realms

of technology and of law”); Tim Wu, When Code Isn’t Law, 89 V

A. L. REV. 679,

682 (2003) (discussing the “interesting and complicated effects” that using code

to “minimize the burden of laws” has on the legal and political system).

21. See Primavera De Filippi & Samer Hassan, Blockchain Technology as

a Regulatory Technology: From Code is Law to Law is Code, F

IRST MONDAY

(Dec. 5, 2016), https://perma.cc/2NFF-LMEP (discussing “a new approach to

regulation, the code-ification of law, which entails an increasing reliance on

code not only to enforce legal rules, but also to draft and elaborate these

rules”); PRIMAVERA DE FILIPPI & AARON WRIGHT, BLOCKCHAIN AND THE LAW:

THE RULE OF CODE 6 (2018) (explaining that “blockchain-based networks run

the risk of creating discrete risks that could destabilize central banking,

financial markets, and the administration of commercial agreements”); Wessel

Reijers et al., Now the Code Runs Itself: On-Chain and Off-Chain Governance

MITIGATING THE LEGAL CHALLENGES ASSOCIATED

WITH BLOCKCHAIN SMART CONTRACTS 1169

comparison of the on-chain versus off-chain arrangements, and

it has been suggested that the former displays striking

similarities to Kelsen’s notion of a positivist legal order.

Hybrid smart contracts, with their combination of on-chain and

off-chain elements, present an additional dimension for

consideration.

Can law and code work together, not merely at

a theoretical level but at a pragmatic logistical level, to advance

contractual efficacy? This Essay seeks to provide an initial

analysis of whether and to what extent hybrid smart contracts

can harness the socio-economic benefits of smart contracts while

also upholding fundamental principles of contract law.

I. T

HE NATURE AND OPERATION OF SMART CONTRACTS

A. Phases of Creation

It is useful to begin by considering the various phases of

creation of a smart contract.

This will form a useful foundation

for the subsequent analysis of the operation of hybrid smart

contracts. In the blockchain structure of smart contracts, each

of the blocks contain hash values of the present and previous

blocks, as well as a timestamp.

The creation of blockchain

smart contracts can be delineated into three distinct phases.

The initial phase consists of multiple users participating in the

development of the contractual terms by using their respective

private keys.

This agreement is then programmed into code.

Once all the participants sign off using their private keys, the

of Blockchain Technologies, TOPOI: INT’L REV. PHIL., Dec. 17, 2018, at 1, 8

(“The legal discourse on the state of exception focuses on the conflict between

the integrity of the legal order and the effectiveness of a government in a state

of emergency.”).

22. See Reijers et al., supra note 21, at 1.

23. See Governatori et al., supra note 8, at 399–402 (comparing

imperative and declarative smart contracts).

24. See

Wang et al., supra note 2, at 2268 (using Ethereum and

Hyperledger Fabric as examples to introduce the operational mechanisms of

smart contracts).

25. See Somboun, supra note 4, at 1140.

26. Id. at 1138.

27. Id. at 1139.

28. Id.

1170 80 WASH. & LEE L. REV. 1163 (2023)

contract is transmitted into the blockchain network.

Phase two

involves the transmission of the contract into each node in the

blockchain network through a peer-to-peer platform (“P2P”).

The verification node stores and packages the contract.

When

consensus is reached, the contract is verified and written into

the blockchain.

B. Means of Verification

The primary means of verification is by ensuring that the

private key signature of the various participants matches the

account.

During phase three, the smart contract will execute

the contract when the predetermined trigger conditions have

been satisfied.

The automation will continue until the contract

has been fully executed.

It is relevant to note that while a

smart contract is created and executed on the graphical

interface, the principles of deployment will differ depending on

the platform used. Common platforms include Ethereum,

Hyperledger Fabric, and EOSIO.

C. Immutability

When formed, smart contracts are immutable as the

program code is recorded on a blockchain. Further, such

contracts are decentralized as the execution of the contract is

29. Id.

30. Id.

31. Id.

32. Id. at 1140.

33. See id. (“The validity of the verified contract will be successfully

executed after consensus.”).

34. See id. (“The state machine and trigger condition of each contract will

push the contract that meets the trigger condition to the queue to be verified.”).

35. Id.

36. A comparative analysis of blockchain platforms is outside the scope of

this paper. For such an analysis, see Xiaoqi Li et al., A Survey on the Security

of Blockchain Systems, 107 F

UTURE GENERATION COMPUT. SYS. 841, 844–50

(2020); Daniel Macrinici et al., Smart Contract Applications within Blockchain

Technology: A Systematic Mapping Study, 35 TELEMATICS & INFORMATICS

2337, 2338, 2347–52 (2018); Qi-Feng Shao et al., Survey of Enterprise

Blockchains, 30 J.

SOFTWARE 2571 (2019); Yun Gao & Han Yan, Middleware

Design in Hyperledger Fabric Blockchain Software Architecture, 48 C

OMPUT.

& DIGIT. ENG’G 2195 (2020).

MITIGATING THE LEGAL CHALLENGES ASSOCIATED

WITH BLOCKCHAIN SMART CONTRACTS 1171

through trustless anonymous individual nodes on the

blockchain, with contractual actions, such as transfer of digital

assets, triggered when predetermined conditions occur.

II. L

EGAL AND TECHNICAL ARTICULATIONS OF HYBRID SMART

CONTRACTS

A. The Legal Discourse

As intimated, legal and technical scholarship diverge in the

way that they describe smart contracts. The law commonly

classifies smart contracts into three forms.

At one end of the

smart contract spectrum are contracts that are primarily

expressed in natural language but have automated performance

of minor terms, such as mode of delivery.

In such an

arrangement, the code of the computer program falls outside the

legally binding contractual arrangement.

The code is merely a

technological tool utilized by one or both parties to execute the

obligations that are articulated by the natural language

contract.

At the opposite end of the spectrum are contracts

which are wholly articulated in code.

These arrangements are

the most difficult to reconcile with traditional contractual law

principles. As such arrangements do not have an accompanying

natural language contract, it can be difficult to discern the

intention of the parties and determine when the elements of

37. See Josh Stark, Making Sense of Blockchain Smart Contracts,

OINDESK (June 4, 2016, 1:39 PM), https://perma.cc/8WBL-SNAP (“These

transactions still require a minimum level of trust to be commercially viable,

but are ill-suited for legal contracts, which are comparatively expensive and

require the involvement of legal persons like a corporation or human.”).

38. See L

AW COMMISSION, supra note 15, at vii (“There are essentially

three forms a smart legal contract can take, depending on the role played by

the code. These are: natural language contract with automated performance;

hybrid contract; or solely code contract.”); see also Max Raskin, The Law and

Legality of Smart Contracts,

1 GEO. L. TECH. REV. 305, 310 (2017) (providing

an analysis of the spectrum of “strong” and “weak” smart contracts).

39. L

AW COMMISSION, supra note 15, at 1.

40. See id. at 22 (“This type of smart legal contract can also be referred to

as an ‘external’ contract, as the code falls outside the scope of the parties’

legally binding agreement.”).

41. See id.

42. Id. at 1.

1172 80 WASH. & LEE L. REV. 1163 (2023)

offer and acceptance have been satisfied.

Even if formation can

be established, it is also difficult to determine which terms have

been incorporated into a contract.

If the terms can be

established, interpretation of such terms is also fraught, as what

is being interpreted is not natural language but the algorithmic

expression of contractual rights and liabilities.

Somewhere in the middle of this spectrum are hybrid

contracts. These are contracts that have some rights and

liabilities written in natural language and others written in the

code of a computer program.

It is relevant to note that even

within such hybrid contracts, the degree of automation differs.

On one side of the contractual spectrum reside hybrid contracts

that are principally articulated in code, with a few terms

articulated in natural language.

The terms articulated in

natural language are commonly overarching terms, such as

those relating to choice of jurisdiction or governing law.

Contractual negotiations may be carried out in natural

language, and the contractual terms articulated in natural

language, with contractual performance undertaken by code.

Another form of hybrid smart contracts involves repeating all

the terms in both the natural and code components.

This could

be done by articulating the terms in the contract and also

43. See id. at 56 (“A more novel situation may arise where the parties

enter into an agreement on a DLT system, or smart contract platform, without

any natural language documents or communications passing between them.”).

44. See id. at 77.

45. Id. at 78.

46. See id. at 28.

47. See id. at 27 (“Consultees said that the nature and degree of the

interaction between natural language and code in a hybrid smart legal

contract varies depending on (amongst others) the intention and sophistication

of the parties, and the smart contract platform.”).

48. See id. at 22.

49. Id.

50. See id. (“At one end of the spectrum, the terms of a hybrid contract

could be primarily written in code with a few natural language terms setting

out, for example, the governing law and jurisdiction.”).

51. See id. at 22–23 (“[T]he same contractual term(s) can be written in

both natural language and in code. The natural language terms can be

incorporated in an accompanying natural language agreement, or in natural

language comments included in the code.”).

MITIGATING THE LEGAL CHALLENGES ASSOCIATED

WITH BLOCKCHAIN SMART CONTRACTS 1173

repeating them as comments to the code in the computer

system.

B. Technical Framings

In contrast to the legal framings discussed above, computer

science articulations of hybrid smart contracts understandably

focus on the logistics of operation. Hybrid smart contracts are

framed as arrangements that combine code running inside the

blockchain (on-chain) with data and computations from outside

the blockchain (off-chain).

The link between these on-chain

and off-chain operations is created through a DON.

This

hybrid system enables the on-chain code to be automatically

augmented to address new scenarios in real-time.

The

on-chain element, the blockchain, operates to maintain the

ledger and provide authoritative custody of the assets of users

and interact with relevant private keys.

The on-chain

blockchain also operates to execute final settlement by

processing irreversible transactions and transferring value

between parties.

In contrast, the off-chain element, the DON,

can interact with external data sources, fetching, validating,

securing and delivering real-time data.

Ultimately, these differences in description and emphasis

between legal and technical discourse are more logistical than

substantive. Still, they are useful to note as we progress towards

52. Id. at 23.

53. See supra note 16 and accompanying text.

54. See B

REIDENBACH ET AL., supra note 16, at 10 (“A hybrid smart

contract consists of . . . . on-chain component . . . . and an off-chain component.

The DON serves as a bridge between the two components as well as connecting

the hybrid contract with off-chain resources such as web services, other

blockchains, decentralized storage, etc.”).

55. See id. at 19 (“A DON is designed primarily to augment the

capabilities of a smart contract on a main chain with oracle reports and other

services, but it can provide those same supporting services to other

non-blockchain systems, and thus need not be associated with a particular

main chain.”).

56. See id. at 20 (defining a ledger as data that “once added, cannot be

removed or modified”).

57. Id.

58. Id.

1174 80 WASH. & LEE L. REV. 1163 (2023)

considering whether and to what extent hybrid smart contracts

can mitigate the legal challenges of using smart contracts.

III. T

HE CAPACITY OF HYBRID SMART CONTRACTS TO MITIGATE

LEGAL CONCERNS ASSOCIATED WITH SMART CONTRACTS

A. Formation—Greater Certainty

Hybrid smart contracts can help support greater certainty

in establishing that a contract has been validly formed. A

foundational principle of contract law is that in order for a

contract to be valid it must demonstrate a common intention by

parties to enter legal relations.

Dissenting in Rose & Frank Co

v. JR Crompton & Bros Ltd.,

Lord Justice Atkin L.J. noted that

this common intention must be objectively determined and

“communicated expressly or impliedly.”

Edington v. Board of

Trustees of the State Public Sector Superannuation Scheme

further held that intention can be discerned from conduct—even

solely from conduct.

In Western Export Services Inc v. Jireh

International Pty Limited,

Justice Hammerschlag noted that

“[i]n ascertaining the intention of the parties . . . regard can be

had to the commercial circumstances in which the parties

exchanged their communications.”

In Banque Brussels

Lambert SA v. Australian National Industries Ltd,

the court

further held that such a principle is necessary to recognize the

“business reality” of parties’ agreements,

with Chief Justice

Rogers noting, “The whole thrust of the law today is to attempt

to give proper effect to commercial transactions.”

59. See Governatori et al., supra note 8, at 382.

60. [1923] 2 K.B. 261 (Eng.).

61. Id. at 293.

62. [2016] QCA 247.

63. See id. at [80] (“Whether there is such an intention in particular

circumstances is to be determined objectively from the outward manifestations

of the parties’ intentions.” (internal quotation omitted)).

64. [2010] NSWSC 622.

65. Id. at [197].

66. (1989) 21 NSWLR 502.

67. Id.

68. Id. at 523.

MITIGATING THE LEGAL CHALLENGES ASSOCIATED

WITH BLOCKCHAIN SMART CONTRACTS 1175

Based on these contractual principles, participating on a

commercial blockchain arguably demonstrates an intention to

enter legal relations with respect to the transactions carried out

on that blockchain.

It can be further argued that agreeing to

transact on the blockchain platform satisfies the elements of

offer and acceptance in relation to the transactions carried out

on the platform.

However, as has been noted in the legal

scholarship, there remains the problem of transitioning such an

aggregated will to all individuals in the blockchain.

Adopting

the legal definition of smart contacts, a code-based contract

accompanied by a natural language contract can enable

substantive legal rights and liabilities to be articulated in the

latter, with the coded component essentially functioning as a

mode of operation clause.

Such an arrangement can help

mitigate some of the uncertainties relating to smart contract

formation.

B. Interpretation—Greater Clarity

Hybrid smart contracts can also support greater clarity in

interpreting contract terms. Legal scholarship has examined the

difficulty of identifying, and then interpreting, the terms of an

agreement where the contractual terms were generated through

69. See Morgan N. Temte, Blockchain Challenges Traditional Contract

Law: Just How Smart Are Smart Contracts, 19 W

YO. L. REV. 87, 104 (2019)

(“Through this lens, a smart contract fulfills the offer requirement through a

posting on the blockchain ledger which occurs in an effort to elicit acceptance.

Acceptance and consideration are both confirmed through the act of

performance of the self-executing smart contract.”).

70. See John Salmon & Gordon Myers, Blockchain and Associated Legal

Issues for Emerging Markets, 63 I

NT’L FIN. CORP.: THOUGHT LEADERSHIP 5

(2019), https://perma.cc/WFY6-45XX (PDF) (“Contract law will likely apply to

the underlying transactions between the parties using smart contracts,

assuming that the arrangement between the participants otherwise fulfils [sic]

the requirements for contract formation.”).

71. See Fairfield & Selvadurai, supra note 7, at 86 (illustrating the

discrepancies between individuals who contract for the same product through

a website versus directly from a smart contract, and exploitation of human to

computer contracting).

72. See Megan Ma, Writing in Sign: Code as the Next Contract Language,

MIT

COMPUTATIONAL L. REP., Aug. 14, 2020, at 2, 5–20, https://perma.cc/4JGL-

WGST (PDF) (discussing how various coding programs translate into natural

language clauses).

1176 80 WASH. & LEE L. REV. 1163 (2023)

interaction on a distributed ledger.

A central problem to be

addressed is the gap that sometimes arises between what the

code was intended to say and what it actually does when it is

executed. This can be described as a “gap between intended

meaning and unintended effect.” Applying the legal definition of

hybrid smart contacts, the blockchain contract can potentially

be connected to natural language aids to interpret coded terms.

As it is part of the one contract, it can be used to interpret the

scope and operation of the on-chain code.

Applying computer

science formulations of hybrid smart contracts, off-chain data

can aid the interpretation of the on-chain terms.

In contrast to

traditional smart contracts, hybrid smart contracts are formed

and executed by two distinct decentralized networks, a

blockchain network and also a DON.

While smart contracts

also utilize the oracle gateway to connect to data sources,

leveraging off-chain computations which are not accessible on

the blockchain, a hybrid smart contract additionally utilizes

DON to create contracts using off-chain data.

This unique

structure of hybrid smart contracts can, hence, potentially

advance legal certainty by connecting the contract to

off-blockchain data. This would aid such legal matters as

73. See Temte, supra note 69, at 98–99 (“[T]he decentralized nature of

[smart contract’s] transactional ledger is a strong advantage of blockchain. But

this decentralization also has drawbacks—the largest being the lack of

opportunity for parties to modify once the smart contract executes.”); Maren

Woebbeking, The Impact of Smart Contracts on Traditional Concepts of

Contract Law, 10 JIPITEC

106, 111 (2019), https://perma.cc/6Q5K-5QMX

(“Particularly precarious, however, remains the interaction between the

interpretation of the smart contract code and a respective underlying written

contract . . . . [I]t will be crucial that the parties stipulate explicitly to what

extent the smart contract code should serve for interpretation.”).

74. See Woebbeking, supra note 73, at 110 (“[I]f there is a need to use

ambiguous clauses in a smart contract, it is likely that interpretational

difficulties will be resolved by assigning them to a human-based oracle.”).

75. See L

AW COMMISSION, supra note 15, at 88 (“Natural language can be

used in various ways to aid the court in understanding and interpreting the

coded terms of a smart legal contract.”).

76. See Hybrid Smart Contracts, C

HAINLINK, https://perma.cc/85XU-

ALMX (last updated May 24, 2023) (“DONs can be used to bridge various types

of external data to and from blockchains, enabling hybrid smart contracts to

be written around those specific pieces of data.”).

77. B

REIDENBACH ET AL., supra note 16, at 9.

78. See id. at 6.

MITIGATING THE LEGAL CHALLENGES ASSOCIATED

WITH BLOCKCHAIN SMART CONTRACTS 1177

determining which terms have been properly incorporated into

the contract and interpreting those incorporated terms.

C. Performance – Greater Flexibility

Arguably, the greatest potential benefit of hybrid smart

contracts relates to contractual performance. Hybrid smart

contracts have the potential to address one of the greatest

problems of traditional smart contracts, inflexibility, while also

maintaining their greatest strength, immutability.

As Lin,

Zhang, Li, Ji, and Sun note, “Tamper proof is the most

remarkable feature in the blockchain, and its specific

performance in that once the smart contract is successfully

deployed, then it cannot be changed.”

However, this strength

also creates one of the most significant problems relating to fully

on-chain smart contracts, inflexibility.

“Purely on-chain

contract code is slow, expensive, and insular, unable to benefit

from real-world data and a variety of functionalities that are

inherently unachievable on-chain, including various forms of

confidential computation, generation of (pseudo) randomness

secure against miner/validator manipulation.”

In a traditional blockchain smart contract, the data that

delineates the terms and conditions is based solely on the

blockchain.

That is, the smart contract is based solely on the

data that is housed in the formal language of the blockchain

programming.

The smart contract is not able to read programs

and protocols that exist outside of the blockchain.

The use of

oracles, middleware that translates outside data onto the

79. See Jeremy M. Sklaroff, Smart Contracts and the Cost of Inflexibility,

166 U.

PA. L. REV. 263, 291 (2017) (“Computer code must be precisely and

completely defined . . . . A smart contract cannot contain a term that has one

meaning at the time of execution and takes on another meaning later.”).

80. Shi-Yi Lin et al., A Survey of Application Research Based on

Blockchain Smart Contract, 28 W

IRELESS NETWORKS 635, 640 (2022).

81. See supra note 79 and accompanying text.

82. B

REIDENBACH ET AL., supra note 16, at 9.

83. See Shi-Yi Lin et al., supra note 80, at 636 (“Smart contract is an

embedded programming contract that can be built into any blockchain data,

transaction or asset to form systems . . . .”).

84. Id.

85. Id.

1178 80 WASH. & LEE L. REV. 1163 (2023)

blockchain, can help mitigate this problem.

As the authors of

Chainlink 2.0: Next Steps in the Evolution of Decentralized

Oracle Networks note,

For smart contracts to realize their full potential therefore

requires smart contracts to be architected with two parts: an

on-chain part (which we typically denote by SC) and an

off-chain part, an executable running on a DON (which we

typically denote by exec). The goal is to achieve a secure

composition of on-chain functionality with the multiplicity of

off-chain services that DONs aim to provide. Together, the

two parts make up a hybrid contract.

The hybrid smart contract system can hence enable the

on-chain code to be automatically augmented to address new

scenarios in real-time. Notable present examples include:

geolocation data that can be used to monitor the flow of goods

through a supply chain, capital market data relating to

tokenized assets and securities benchmarks reference data,

such as interest rate data relating to smart financial

derivatives, and meteorological data used for a variety of

purposes, including insurance.

Such off-chain data can include

changing information as to the price of assets, updated

information as to reserve balances supporting tokenized assets,

and other data from application programming interfaces.

This

latter category can cover a wide range of data including

agricultural harvests and mining information.

It is conceivable

that such off-chain data could include legal repositories of

material relating to contractual terms and their intended

operation, as well as data relating to external events such as

those relevant to the application of the doctrine of frustration.

86. See LAW COMMISSION, supra note 15, at vii (defining a smart contract

as computer code that “is capable of running automatically according to

pre-specified conditions”).

87. B

REIDENBACH ET AL., supra note 16, at 9.

88. See Woebbeking, supra note 73, at 108 (“The fields of application of

smart contracts are numerous. They can be used, at least in theory, wherever

economic assets show interfaces to the internet and certain events can be

verified digitally.”).

89. See B

REIDENBACH ET AL., supra note 16, at 8, 27 (discussing DONs’

asset access).

90. See Hybrid Smart Contracts, supra note 76 (describing how hybrid

smart contracts can benefit different global industries).

MITIGATING THE LEGAL CHALLENGES ASSOCIATED

WITH BLOCKCHAIN SMART CONTRACTS 1179

The on-chain element, the blockchain, continues to operate to

maintain the ledger and provides “authoritative custody of

users’ assets and interacts with private keys.”

Final settlement

is executed by the blockchain through the processing of

irreversible transactions and the transferring of value between

parties.

Finally, the on-chain blockchain can also provide

appropriate guardrails to ensure the secure functioning of the

off-chain activities executed by the DON.

ONCLUSION

At present, the most prevalent form of automated contracts

are natural language contracts with automated performance.

Such contracts do not offer the full benefits of smart contracts,

most notably their features of ease of formation and trustless

contracting through the removal of the need for

intermediaries.

However, the transition to smart contracts is

discernable and accelerating.

The United Kingdom Law

Reform Commission’s 2021 report, Smart Legal Contracts:

Advice to Government, notes that the prevalence of contracts

recorded solely in code “might increase over time as the

underlying technology becomes progressively sophisticated.”

While developments in blockchain technologies have led to a

new “crypto-economy,” the next generation of decentralized

applications will be facilitated by the increasing use of smart

contracts.

91. Id.

92. Id.

93. Id.

94. See L

AW COMMISSION, supra note 15, at 26 (“Of the 22 consultees who

answered this question, 11 said natural language contracts with automated

performance are most commonly used in practice.”).

95. See id. at 22 (“The code itself does not define any contractual

obligations, but is merely a tool employed by one or both of the parties to

perform those obligations.”).

96. See id. at 26.

97. Id. at 30.

98. See Shafaq Naheed Khan et al., Blockchain Smart Contracts:

Applications, Challenges, and Future Trends, 14 P

EER-TO-PEER NETWORKING

& APPLICATIONS 2901, 2920 (2021) (“Thus, smart contracts are expected to

1180 80 WASH. & LEE L. REV. 1163 (2023)

Despite this growing commercial interest in the use of

smart contracts, there is an increasing legal concern as to the

capacity of smart contracts to uphold fundamental principles of

contract law.

In such a context, it is suggested that hybrid

smart contracts can offer many of the benefits of fully automated

smart contracts while also mitigating some of the primary

concerns.

100

This Essay has provided a preliminary exploration of hybrid

smart contracts’ potential to mitigate problems relating to

uncertainty, lack of clarity, and inflexibility. It is relevant to

note that this is merely an initial scoping analysis. For this

analysis to progress, it will be necessary for lawyers to formally

collaborate with computer engineers and data scientists to

connect legal and technical understandings. Lawyers are

well-versed in the contractual principles that need to be

maintained, but are less familiar with how blockchain

infrastructure and smart contracts can be designed to uphold

these principles.

101

Conversely, technical experts understand

the logistical operations of smart contracts but are not familiar

with the substantive law to be upheld.

102

As in many other fields

of technology law, it is only in the coming together of disparate

disciplines that meaningful progress can be made.

103

The use of

DONs to mitigate the inflexibility of a fully smart contract has

not been the subject of legal analysis. Yet, this unresearched

arrangement could form a key to overcoming some of the most

significant contractual challenges identified in the legal

literature on smart contacts.

revolutionize many traditional industries, such as financial, healthcare,

energy, etc.”).

99. See supra Part III.

100. See supra Part III.

101. See L

AW COMMISSION, supra note 15, at 25 (“Many consultees

emphasized [sic] the importance of coders in the formation of a smart legal

contract. The parties may contract with a computer coder to draft the code

based on instructions provided jointly to the computer coder by the parties.”).

102. See id.

103. See Gacutan & Selvadurai, supra note 15, at 72 (“An understanding

of Internet structure is thus critical to the design of effective laws to restrain

the sharing of harmful user-generated content.”).