The legalisation of Smart Contracts

Do they have legal validity?
Can they be equated with traditional contracts?

Do smart contracts have legal validity?

To answer this question, it would first be useful to provide a clear and simple definition of what smart contracts are.

Is there a definition of a smart contract?

It should be noted that there is no single definition. The so-called “smart contracts” (also known as distributed applications) were first theorized by Nick Szabo in 1994 and defined as “automated transaction protocols that execute specific contractual terms.” ¹

Essentially, they are event-driven software that operates according to the “if this then that” logic, where contractual effects occur only upon the fulfillment of certain conditions, through an automatic translation of code without any human intervention. Therefore, there is no written agreement containing the terms and conditions agreed upon by the parties; instead, there are cryptographic codes capable of automatically executing actions (or instructing certain actions to be performed) once the conditions determined by the parties are met and verified.

In other words, only upon the occurrence of condition X can the implementation and development of condition Y proceed: this mechanism is divided into many “blocks” (with smart contracts forming the building blocks of each), which together create a “chain of blocks” (so-called “blockchain“).
Once block 1 is completed, it becomes definitive and immutable and can never be deleted or modified: the only option to continue the contract is to move on to the next block. This occurs by solving a complex mathematical problem that only so-called miners, operators equipped with computers with exceptional computing power, can solve.

At the European level, the so-called Data Act ² (although not yet in effect) in its final draft defines “smart contracts” ³ and also describes their essential ⁴ requirements: there is a dedicated article containing some provisions aimed at defining modification requirements for smart contracts (including so-called “kill switches“) and establishes some rules for parties providing shareable data, including “safe termination and interruption” of smart contracts while also integrating safeguards to preserve trade secrets and prevent unlawful data transfers.

And in Italy?

In Italy, smart contracts have also been granted legal status through the so-called “Simplification Decree ⁵,” which states:
“A ‘smart contract‘ is defined as a computer program that operates on technologies based on distributed ledgers and whose execution automatically binds two or more parties based on predefined effects by the same.

Smart contracts meet the requirement of written form provided that the interested parties are identified electronically through a process having the requirements set by the Agency for Digital Italy with guidelines ⁶ to be adopted within ninety days from the effective date of the conversion law of this decree.”

What are the main characteristics of smart contracts?

• Irrevocable: A smart contract, once recorded on a blockchain, cannot be dissolved or modified once the conditions within it are met, and the contract automatically goes into execution.
  
  
  
• Digital form: Although they satisfy the requirement of written form (in the case of prior electronic identification of the interested parties through a process of electronic timestamp validation) ^7.
  
  
  
• Articles as cryptographic codes: These can be read not only by individuals but also by hardware (thus by objects).
  
  
  
• Distributed and validated by blockchain: Therefore, they do not require a legal intermediary (e.g., the figure of a lawyer or notary).
  
  
  
• Totally transparent

Given their legal qualification, do smart contracts therefore have full legal validity?

Unfortunately, the debate is still ongoing, and there are various opinions and theories, which, however, start from a common distinction into two macro categories ⁸:

1. Smart contract code: Identifies a code that is “written” on the blockchain. This definition is mainly used by developers and refers to the underlying code, which cannot therefore be equated with a contract.
   
   
   
2. Smart legal contract: A specific application of the smart contract code that complements or replaces traditional contracts. This definition is seen by many as a combination of programming code and legal language.

Given this macro-division, the smart (legal) contract is equated with contracts according to some theories because:

• It is a means of fulfilling obligations where the terms and conditions are written in the code, the smart contract evaluates the terms imposed by the agreement according to the “if this then that” logic and automatically applies what has been agreed upon.This automatic execution would constitute a guarantee of compliance ⁹.
  
  
  
• It is a negotiated agreement that is “notarized” irrevocably on the chain, thereby also avoiding the risk of non-compliance by one of the parties ¹⁰.
  
  
  
• It is a real contract but enhanced, in the sense that the additional features of the blockchain would attribute greater effectiveness to the same in terms of negotiation (think of the self-execution of the blockchain and the registration of all negotiation phases on it).
  
  
  
• The material action of starting the program would constitute a full manifestation of the will of the parties (including that of executing what has been instructed) ¹¹ and would therefore seem to meet the minimum contract requirements under articles 1321 and 1322 of the Civil Code.

However, there is also a large part of the doctrine that argues that there are legal limits to this equation (technical limits will not be addressed here) and therefore considers smart contracts as a separate category. What are these limits?

• Identification of the fundamental elements of the contract: Considering Italian law, a contract should contain the elements of art. 1325 of the Civil Code, which, however, are not easily identifiable within a cryptographic code.
  
  
  
• Interpretation of some legal terms: Often, the drafting of traditional contracts requires the use of terms that need to be interpreted and “adapted” to practice depending on the different cases, translating all this into a cryptographic code would be quite difficult.
  
  
  
• Traditional contracts often include clauses (albeit ancillary) of suspension/resolution and/or termination events: How to relate (and therefore condition) a smart contract (which we know to be unmodifiable) to such external events (or in jargon also “supervening events”)?
  

To conclude.

It is now established that in Europe (including Italy), steps have been taken towards the attribution and recognition of legal status to smart contracts; however, regarding their equivalence to traditional contracts, despite the ongoing debate, it is very likely that they will give rise to a new and different category, perhaps precisely that of smart legal contracts.

¹ Regulation (EU) 2023/2854 concerning harmonized rules on fair access to and use of data and amending Regulation (EU) 2017/2394 and Directive (EU) 2020/1828 (Data Act) – issued on December 13, 2023, which will be fully applicable in September 2025.

² Data Act, art. 2, “No. 39) ‘smart contract’: a computer program used for the automatic execution of an agreement or part of it using a sequence of electronic data records and ensuring the integrity and accuracy of their chronological order.”

³ Data Act, art. 36 “Essential requirements relating to smart contracts for the execution of data-sharing agreements.

⁴ Conversion Law of February 11, 2019, no. 12, amending Decree-Law of December 14, 2018, no. 135, containing “Urgent provisions on support and simplification for businesses and public administration” grants legal recognition to technologies based on distributed ledgers (so-called “DLT”) and smart contracts. The definition of smart contracts is described in art. 8 ter, paragraph 2.

⁵ On May 7, 2020, the Agency for Digital Italy (AGID) issued, pursuant to art. 71 of the Digital Administration Code (“CAD”), the guidelines on best practices for secure design of architectures based on distributed ledgers, in accordance with the principles of “Secure/Privacy by Design.”

⁶ This means that the date and time of the electronic document, if recorded on the blockchain via a smart contract, can also be opposed to third parties (as provided by art. 41 EU Regulation no. 910/2014 “Legal effects of electronic timestamp validation”).

⁷ Catholic University of the Sacred Heart, Roma Tre University “Characteristics of smart contracts” draft. 1.0, June 2023, available at https://www.bancaditalia.it/media/notizie/2023/Draft_Protocollo_smart_contract.pdf

⁸ Bank of Italy, Catholic University of the Sacred Heart, Roma Tre University “Characteristics of smart contracts” draft. 1.0, June 2023, available at https://www.bancaditalia.it/media/notizie/2023/Draft_Protocollo_smart_contract.pdf

⁹ *Rinaldi, G. “Smart contract: mechanization of the contract in the blockchain paradigm,” in G. Alpa, Law and artificial intelligence (2020) pp- 353-354

¹⁰ Rinaldi, G. “Smart contract: mechanization of the contract in the blockchain paradigm,” in G. Alpa, Law and artificial intelligence (2020) pp- 353-354.

¹¹ Sklaroff J. M., “Smart contract and the cost of inflexibility”, University of Pennsylvania Law Review, Vol. 166 (2017) pp. 217 ss.. Per un’analisi più dettagliata si rimanda al documento pubblicato dalla Banca d’Italia e sopra citato