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Smart Contract Arbitration Model: A Solution for Consumer Disputes Globally

Manavendra Gupta is a 2023 LL.M. candidate at Berkeley Law.

A diagram of the Smart Contract Arbitration Model. Illustration by Kleros. Creative Commons Fair Use.

The average consumer often experiences a power imbalance when embroiled in disputes with giant corporations. These legal conflicts arise in various forms and exist globally. Be it homebuyers betrayed by builders who divert their deposits and fail to deliver homes on time, patients in hospitals during COVID-19 whose medical bills were not honored by insurance companies, consumers who are duped through improperly inflated utility bills, or customers whose grievances are ignored by e-commerce giants. Litigation seldom benefits the average person. The endless resources of corporations for inflicting long-drawn, expensive court battles dwarf the meager resources of working families. In these cases, a method of redress having the virtues of both a fair and cost-effective mode of adjudication and a firm and rapid enforcement of relief is required. This kind of adjudication comes in the mechanism of a smart contract (“SC”). N. Szabo, “Smart Contracts: Building Blocks for Digital Markets”, Extropy 16 (1996). Combining SC and traditional arbitration merges SC's speed with arbitration's fairness. This creates a robust dispute resolution model.

SC is noted for its instant enforceability. It works on an “if-then” code model and is embedded with a prescribed criterion. When the criterion is met, the blockchain automatically releases the virtual currency kept in escrow. Think of it like a vending machine, where you decide what you want and insert money into the device. Once you click on the button or insert the code for the item of the same value, the machine automatically releases it. With a slight tweak, SC can replace the traditional consumer contract that inevitably favors the corporation. The problem with SC is that its execution is a little too rapid, and the process lacks any method of adjudication. Some adjudication becomes essential because of SC’s inherent limitations, such as permanence and immutability. SC is also unable to account for commercial realities between contracting parties. If SC is used alone, consumers would execute the contract immediately, but corporations would feel aggrieved for not being heard on their objections. Without due adjudication, execution of SC would be quick but not necessarily fair.

On the other hand, arbitration promises fast and cost-effective adjudication but lacks a mechanism for speedy enforcement of the award. If arbitration is used alone, assuming consumers have favorable awards, then they will still need to resort to the very courts they wanted to avoid for enforcement. Many consumer contracts include the arbitral remedy, but this has proved highly ineffective. The corporation either appoints the arbitrator unilaterally or else habitually challenges the award, preventing speedy enforcement.

For consumer disputes, the “SC-arbitration” model with a fusion of SC and arbitration is the best of both worlds. Under this scheme, the consumer can use the transparent digital ledger in the SC blockchain to easily understand contractual obligations, monitor the transactions undertaken by the corporation, and ensure that funds are utilized appropriately. SC may also suit a corporation that faces defaults by its subscribers. When a dispute arises, a short cooling-off period can be mandated before execution of the SC for the aggrieved party. This quickly invokes the arbitral remedy. Arbitration can adapt to evolving technologies and even operate virtually. Therefore, it can be embedded in the SC itself. Parties can agree either to nominate an arbitrator in advance from a randomly generated list on the SC blockchain or opt for institutional arbitration. The mode of appointment should be required when “signing” the SC to prevent a unilateral appointment of an arbitrator by the corporation.

SC can then make the award of the arbitrator the prescribed criterion required to be met in its blockchain for contract execution. The “multi-sig” algorithm can be used for this purpose. See K. Itakura and K. Nakamura. A public-key cryptosystem suitable for digital multisignatures. NEC Research and Development, 71:1–8 (1983). Multi-sig confers rights on multiple users, including third parties, to execute a digital transaction. The arbitrator can (as one such user), upon delivering the award, transfer the virtual currency stored in the blockchain instantaneously to the successful party with the mere click of a button. Even in the absence of virtual currency, where parties are dealing in fiat money, SC can securely encrypt the bank account details of parties in the blockchain. The bank can be added to the multi-sig list and can hold another key to execute the SC upon notification by the arbitrator. Thus, the SC-arbitration model will prove to be a fair, speedy and self-contained remedy.

The SC-arbitration model can significantly solve the problem of unequal bargaining power in commercial transactions and deliver a just outcome. Where SC will be deficient in adjudication, the arbitral method will provide fair decision-making. When arbitration is weak in enforcement, SC provides strength. As the world is rapidly shifting from brick-and-mortar establishments to AI and e-commerce, the SC-arbitration model simply and efficiently resolves global disputes.

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