Locke Lord QuickStudy: Down the Rabbit Hole: Digital Assets in ‎International Arbitration

Summary: The global adoption of digital assets and related blockchain technology has network ‎effects, which suggest that programmable legal contracts, including automated dispute resolution ‎mechanisms, might not only be feasible but one day common in international transactions and ‎arbitration. Obstacles to this outcome include, inter alia, still nascent regulatory guidance on digital ‎assets and lack of interoperability, both among blockchains and legacy software applications. ‎

Introduction ‎

Recent innovations in dispute resolution include the creation of opt-in computing protocols (or smart contracts) that rely ‎on blockchains, game theory and crowdsourcing to adjudicate disputes and provide automatic ‎enforcement of decisions when certain predetermined conditions are met. ^[1] In 2021, the UK Jurisdiction Taskforce published the Digital Dispute ‎Resolution Rules (DDR Rules), which start from the proposition that the “outcome of any automatic ‎dispute resolution process shall be legally binding on interested parties” and that the DDR Rules will ‎address via arbitration “any dispute between interested parties arising out of the relevant contract or ‎digital asset which was not the subject of an automatic dispute resolution process. ^[2]

Does the integration of automatic dispute resolution into traditional arbitration show the way for the future of dispute resolution involving digital assets and technology specifically? Or does it show the way for the future of arbitration more generally? There are ‎arguments in favor of both views. But the outcome may ultimately depend on whether and when there ‎is mass adoption of digital assets and related technologies, including smart contracts.  

Digital assets ‎

Digital assets refer to coded property, which may be fungible (like a digital currency token) or non-‎fungible (like an original digital artwork).^[3] The existence of digital assets depends largely on ‎cryptographic algorithms and consensus-forming protocols, which enable parties to secure, transfer, ‎and indelibly record ownership on (in some cases) 1000s of identical and globally distributed public ‎ledgers known as blockchains.‎

Because blockchains can be decentralized and rely on open-source software to solve problems traditionally ‎addressed by institutions – e.g., preventing someone from “double spending” the same token of ‎economic value^[4] ‎– blockchains may offer not only security, permanency, and transparency for ‎transactions, but also cost efficiency.^[5] Further, because in principle any type of decentralized ‎software application (dApp) may utilize blockchains,^[6] they have a range of possible use cases, ‎from providing financial services to managing oil and gas supply chains, all potentially accessible via ‎a decentralized internet, Web3.^[7]

For businesses who aim to integrate digital assets and related technologies, novel regulatory ‎questions arise in a number of settings:‎

• What are digital assets from a regulatory standpoint? How does the CFTC ‎classify digital commodities, for example?^[8] Can digital assets be supported by ‎banking providers? In which jurisdictions?^[9] What about “stable coins”^[10] pegged ‎to the USD or Central Bank digital currencies? ‎
• The World Bank issued a “Blockchain Bond”^[11] using distributed ledger ‎technology. Can we use this for security and transparency? Should we?‎
• Which regulated entity would be best suited for digital assets in our portfolio? As ‎for potential holdings: Where do Non Fungible Tokens (NFTs) of digital media ‎actually exist? Who has custody? ‎
• If an entity converts digital assets to fiat currency how is this taxed? Do KYC / AML ‎‎/ CTF compliant digital asset exchanges issue 1099s? Also, what about digital ‎native 501(c)(3) donor advised funds? Does one sell first or does the fund do this ‎later? ‎
• If the real estate project is owned by a Digital Asset Organization (DAO), can we ‎propose fractional property rights for 10,000 individuals worldwide evidenced by ‎digital tokens, which also enable governance?^[12]

Many of these issues require a deep dive. Do similarly novel technical or legal issues arise for ‎international arbitration? One answer is surely, no. Arbitration is technologically agnostic and already ‎at home with cross-border transactions. Moreover, digital assets are subject to regulation like any ‎other asset. Provided a given digital asset can be classified – e.g., as a commodity, such as gold, or a ‎currency, such as USD, or as a security, such as stock – such assets can be analyzed within the ‎framework of a bilateral treaty’s definition of investment or a nation’s legal definitions of property.^[13]

Likewise, from a procedural standpoint, there is arguably little to adjust. Millions of digital asset ‎transactions are already completed subject to established commercial arbitration rules such as JAMS ‎or AAA. A HKIAC arbitration with up to 700 claimants seeking damages for loss of digital assets is ‎reportedly pending.^[14] This is not too surprising. Incorporating arbitration rules “by reference” into a ‎contract on any subject matter is a semantic and legal notion, not a technological one. ‎

That said, this general view is worth reconsidering given the enormous expansion of digital asset ‎markets (to trillions of USD) and the parallel adoption of related blockchain technologies. In ‎particular, one may further consider the following: ‎

• Why international dispute resolution is largely technology agnostic. ‎
• Why a change in the nature of legal agreements and, hence, international dispute ‎resolution provisions, might alter this state of affairs. ‎
• Why digital assets and related technologies, specifically, might enable this change and ‎make it more likely than not. ‎

International arbitration ‎

As a dispute resolution mechanism for cross-border transactions and investments, international ‎arbitration is enforced by one of the most important and successful treaties in the history of private international law, i.e., ‎the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, 1958) ‎‎(the "New York Convention"). The New York Convention is in force in 169 countries to date and is ‎only one of several treaties ‎(e.g., ICSID Convention)‎ in support of the enforcement of arbitration agreements and ‎arbitral awards worldwide.^[15]

Historically, dispute resolution within this framework has proven resilient and flexible. Arbitral ‎institutions routinely adopt procedural rule changes, as well as technological innovations to deal with ‎ediscovery, docket management systems, and virtual hearing platforms. At the outset of the global ‎pandemic in 2020, many arbitral institutions already had digital platforms and/or virtual hearings to ‎allow litigants to participate in far-flung jurisdictions. Moreover, the adoption of these technologies ‎was possible with ameliorative rather than fundamental changes to their procedural or legal ‎framework. ‎

Ultimately, however, this steady state of affairs largely endures because of the users of arbitration, not its ‎facilitators. Specifically, whatever else about the world has changed, the basic mode of contracting ‎commercial agreements or treaties has changed little: a digital copy of a contract (even a digitally ‎signed copy) does not much alter its terms or legal underpinnings or the means of resolving disputes ‎that may arise because of it. ‎

The same might be said even if parties decide to use a ledger or blockchain to negotiate, sign and ‎record agreements, i.e., for the sake of security, transparency and permanency.^[16] But there are ‎potentially disruptive forms of contracting. ‎

Smart Legal Contracts ‎

In the 1990s, cryptographer Ian Grigg proposed capturing the intent of legal agreements in machine-‎readable language in order to create programmable legal contracts that could connect to computing ‎networks and self-execute if certain agreed conditions were met, say payment or shipment terms, as ‎evidenced by inputs from networks to which the contract was connected.^[17] In principle, network ‎nodes might also include, for example, models for mapping the critical path of construction projects to ‎adjudicate delay damages or inputs for calculating interest, currency conversions, or spot prices ‎among interrelated contracts.‎

Smart legal contracts in this sense could have many forms.^[18] A digital legal “wrapper” may be put ‎around digital art or any digital token representing ownership of a tangible asset. These wrappers ‎may articulate licensing, fractional ownership, or chain of title. Within this context too, parties may ‎include programmable dispute resolution mechanisms: When certain events occur, a pre-agreed ‎dispute resolution mechanism can be triggered, along with follow-on procedural events executed by ‎an automated dispute resolution platform.‎

Automatic Dispute Resolution

One such platform, Kleros,^[19] uses computing protocols to adjudicate disputes with ‎competing but clear possible outcomes and to enforce the resulting decisions automatically, e.g., using ‎escrowed funds. When parties opt-in and agree to automatic enforcement via smart contracts, they ‎are also able to select the number of voting arbitrators and their (non-legal) industry specialization. ‎These arbitrators are crowdsourced anonymously from a pool of participants in the event a dispute ‎arises.‎

While such arbitrators or “jurors” are financially compensated, arbitrators whose votes do not agree ‎with the ultimate ruling, which is not disclosed until final decision is reached, forfeit part of the ‎financial “stake” they post in order to participate in the resolution process. Parties can appeal. ‎However, each new appeal will have twice the previous number of arbitrators plus one and ‎thus come at a greater cost to the appellant, who is dis-incentivized from appealing more than a ‎‎“moderate” amount of times.‎

Digital Asset Arbitration

The above process provides a means to resolve some digital asset disputes with fading resemblance ‎to typical arbitration procedures. The UK Jurisdiction Taskforce’s DDR Rules consider such ‎mechanisms explicitly, by stating that all or part of a dispute may be subject to such protocols, ‎alongside more traditional adjudication for any issues not so resolved. Under the DDR Rules, “an ‎automatic dispute resolution process means a process associated with a digital asset that is ‎intended ‎to resolve a dispute between interested parties by the automatic selection of a person or panel or ‎artificial ‎intelligence agent whose vote or decision is implemented directly within the digital asset ‎system . . . ”‎ ‎

The DDR Rules themselves have some features in common with automatic dispute resolution such ‎as the option for parties to remain anonymous and for decisions to be enforced and recorded on ‎chain. At the same time, the DDR Rules retain procedures, which put it squarely within a legal ‎framework for enforcement. Thus, the DDR Rules rely on the Society for Computers and Law to ‎appoint arbitrators and propose London as the seat of arbitration and English law as the substantive ‎law of contracts.‎

While neither automatic dispute resolution nor digital asset arbitration rules may be necessary to deal ‎with disputes involving digital assets, these approaches seek to meet the needs and preferences of ‎their end users. To take a step further: it is plausible that a digital convergence of contractual ‎agreements, decentralized networks, and business practice could make smart legal contracts, and automatic dispute resolution, not only ‎feasible but ubiquitous. ‎

The broad adoption of smart legal contracts, however, presupposes (among other things) that ‎individuals and companies may expect a high degree of interoperability and cross-chain compatibility ‎for their smart legal agreements to operate, i.e., that their funds, contracts, products, services and data will ‎function harmoniously despite residing on different blockchains or electronic data interchange ‎systems (EDI) or other legacy networks (including banking). Further, broad adoption presupposes a stable and clear ‎regulatory environment^[20] that can support institutional and retail participation. All of this is work in ‎progress. ‎

Network effects

The mass adoption of technology often lags behind its creation. Queen Elizabeth II sent an email in ‎‎1976, but mass adoption was still twenty years off. For the purpose of divining the impact of digital ‎assets on legal agreements, and hence international commercial or treaty arbitration, the most ‎important feature is thus arguably network effects. Without them, you have video conferencing in ‎‎1968 or email in 1976 - interesting to note, but not enough people are able or incentivized to use ‎them in a business context. ‎

By contrast, if network effects are present and positive, users begin to derive more value as other ‎users join the same network. Because additional users increase the value of the network, non-users ‎are incentivized to join. This feedback loop can spark mass network participation. Social media is one ‎example and often considered illustrative of Metcalfe's Law, i.e., the value of a network is proportional ‎to the square of the number of its users.‎

Digital assets may have added impact in this regard because they involve the exchange of value ‎itself. If the adoption of digital assets - as currency, as stores of value, as property, or as tokens of ‎tangible asset ownership – continues to accelerate and be a driver of change, the network effects ‎resulting from connected and related technologies (including Al and smart legal contracts), suggest exponential change is in store for ‎business and finance built on this new infrastructure.‎

Many aspire to reach this goal: for example, by creating 3D virtual communities in which individuals ‎use a digital persona to both work and play. To the extent individuals are rewarded for participating, ‎financially or otherwise, the migration to virtual worlds is sometimes called “gamification.” This can ‎occur in closed centralized networks, e.g., controlled by a single company, or on open, decentralized ‎networks governed by programmable rules. In the latter case, value and ownership may not simply ‎accrue to a proprietary platform, which visitors merely use, but instead accrue directly to users (e.g., ‎via “digital wallets” they alone control and which enable self-custody of assets and information, as well as enable financial transactions).‎

The totality of such projects is one view of the so-called metaverse, i.e., a persistent 3D digital ‎environment in which individuals, teams, companies or organizations across legal jurisdictions may ‎carry out analog world projects, as well as many new digital ones. The metaverse is a native habitat for digital ‎assets but also, potentially, creatures of contract, such as smart legal contracts, automatic dispute ‎resolution, and the international arbitration rules and institutions supporting them. ‎

Because digital assets may touch nearly every industry sector and do so globally– e.g., through ‎payment rails, tokenization of assets, finance applications, or even legal tender–businesses large ‎and small can anticipate a role in digital asset economies, whether to their advantage or ‎disadvantage. It is thus increasingly important to consider how these technologies may impact one’s ‎business, foreign investments, and related disputes, both procedurally and substantively.‎

For more information on the topics discussed in this Locke Lord QuickStudy, contact the ‎author at ‎paul.neufeld@lockelord.com. ‎

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[1] See, e.g., Kleros.
[2] Digital Dispute Resolution Rules
[3] The DDR Rules define digital assets as follows: “a digital asset includes a cryptoasset, digital token, smart contract or other ‎digital or coded representation of an asset or transaction; and a digital asset system means the digital environment or ‎platform in which a digital asset exists;”. ‎
[4] Solving the double spend problem was critical for the invention of Bitcoin as set out by its pseudo anonymous author(s) in ‎the ‎Bitcoin white paper. ‎
[5]  There are, however, technological challenges, including resolution of the so-called blockchain trilemma: decentralization assists ‎with security, but scalability (i.e., supporting a high number of transactions) has proven difficult in this environment. There are also cost challenges, e.g., minimizing the transaction fees (or “gas”) that users must pay in the blockchain’s currency in order to execute smart contracts on chain. ‎
[6] The blockchain typically credited with pioneering this ‎approach is Ethereum: a decentralized and open ‎source blockchain that ‎‎supports software applications. One of the problems Etheruem sought to solve was how to enable and secure ‎ownership over a spectrum of user-created content otherwise held on proprietary ‎servers. As initially conceived, Ethereum ‎was inspired by Bitcoin blockchain, ‎including its consensus mechanism for adding new blocks to a chain, i.e., Proof of Work. ‎
[7] Because blockchains typically have limited storage capacity, use cases often depend on decentralized file storage systems ‎that distribute information on numerous nodes off-chain, e.g., IPFS. ‎
[8] See, e.g., the CFTC guidance on the classification of digital assets and, in particular, Bitcoin: Despite Bitcoin’s introduction as a “digital cash system,” it is often described as ‎a ‎fixed ‎supply, reserve asset, rather than a payment rail (though payment is a focus of certain forks of Bitcoin). In the US, Bitcoin ‎has been ‎classified as a ‎commodity for regulation purposes, along with gold and oil.‎ ‎The analogy may be apt. ‎Despite being ‎entirely digital in nature bitcoin ‎is by design limited in supply (to 21 million ‎BTC). ‎Moreover, ‎Bitcoin is created and its transactions verified via “mining” (i.e., ‎the energy intensive ‎process known as Proof of Work).
[9] For example, in Wyoming, which is home to early efforts to enable banks to be custodians of digital assets and ‎bridges to the US dollar, Bill No. HB0043 (effective July 2021) identifies a digital asset as intangible property under UCC Article 9. ‎Under the definition in W.S. 34-29-101, a digital asset “means a representation of economic, proprietary or access rights that ‎is stored in a computer readable format and is either a digital consumer asset, digital security or virtual currency.”‎
[10] See, e.g., President’s Working Group on Financial Markets Releases Report and Recommendations on Stablecoins, and Money and Payments: The U.S. Dollar in the Age of Digital Transformation ‎
[11] World Bank
[12] Quick Study, The Tokenization of Real Estate
[13] See, e.g., Legal Statement on Cryptoassets and smart contracts, UK Jurisdiction Taskforce
[14] Kluwer Arbitration Blog
[15] United Nations International Commission on Trade Law
[16] Recently, some states have modified their versions of The Uniform Electronic Transactions Act (UETA) to address ‎blockchain and smart contracts. For example, "The Arizona UETA now provides that a signature secured through blockchain ‎technology is considered to be an electronic signature, and a record or contract that is secured through blockchain ‎technology is considered to be an electronic record. Further, a smart contract may not be denied legal validity or ‎enforceability solely because that contract contains a smart contract term." S. 19.8 of Brian T. Casey and Patrick J. Hatfield's ‎chapter on Financial Services Electronic Signature's and Electronic Records, in PLI's Fintech, Regtech and the Financial ‎Services Industry (2021).‎
[17] So described, programmable legal contracts have gone by a variety of names including Ricardian contracts. Whereas “smart contracts” typically refer to programs that run on blockchains and execute according to a set of predetermined conditions, “smart legal contracts” may be designed to function on or off chain.
[18] See e.g., Accord Project,
[19] Kleros, https://kleros.gitbook.io/docs/kleros-faq/ and https://kleros.io/yellowpaper.pdf.‎ Kleros reports it has resolved over 1000 ‎disputes to date.‎
[20] The diminished role of traditional intermediaries can pose a practical challenge for ‎regulation, which often relies on ‎gatekeepers to track and enforce compliance, e.g., the US Bank Secrecy Act. Many options still exist, however, including ‎focus on regulated asset exchanges, licensed bank custodians, digital asset issuers, and software tools that scan and ‎analyze blockchain transactions, e.g., etherscan. In this regard, a stable regulatory environment‎ aided by self-‎regulation is still evolving. ‎