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On-Chain vs Off-Chain Arbitration in Crypto Disputes

Authors: Syedur Rahman, Rhys Evans  12 May 2024
6 min read

Syed Rahman and Rhys Evans assess the role arbitration can play in crypto-related disputes.

As the frequency of crypto disputes continues to increase, many are now exploring different methods of alternative dispute resolution (ADR). Whilst historically the courts have been the primary forum to resolve such disputes, some are now seeing the benefits that ADR can offer, bearing in mind the nature of decentralised finance (De-Fi). 

One possible mechanism of ADR is arbitration. Whilst arbitration is by no means a new concept to crypto-related disputes, with many online service providers such as crypto exchanges and marketplaces having arbitration clauses within their standard terms of use, new forms of arbitration are becoming increasingly popular. 

 “Off-chain” arbitration typically follows traditional arbitration procedures and adopts arbitral rules or specific blockchain rules, such as those established by JAMS (the JAMS Smart Contract Rules), which provide rules for those seeking to arbitrate disputes relating to smart contracts. What is seemingly becoming a much more attractive option is “on-chain” arbitration. On-chain arbitration covers a wide range of procedures for resolving disputes outside the court arena. Although there is clearly quite some way to go with their development, there are some truly innovative processes being implemented, as is discussed in more detail below. 

Off-Chain 

As noted above, many crypto exchanges and marketplaces already draft arbitration clauses into their standard terms of use in the event of a dispute arising. As an example, the current world’s largest crypto exchange, Binance, sets out in its terms of use that any dispute shall be “determined by mandatory final and binding individual (not class) arbitration administered by the Hong Kong International Arbitration Centre”. 

Many of the traditional pros and cons that are voiced in arguments for litigation or arbitration still apply when dealing with crypto-related disputes. 

Jurisdiction

Given the usually multi-jurisdictional nature of crypto transactions and dealings, having flexibility to choose the rules under which disputes are to be arbitrated lends itself to better dealings with any jurisdictional barriers. This also has an impact on the enforceability of an award following the arbitration itself. Awards are far more easily enforced through the New York convention, to which there are over 150 signatory states. However, enforceability is not 100% guaranteed. It remains unclear to what extent signatory states to the New York convention will consider some distributed ledger disputes to be falling foul of the public interest exception to enforcement. Furthermore, clearly stating which seat and the applicable law will help ease any issues arising out of jurisdiction. 

Arbitrator

Aside from monetary value alone, crypto disputes can, and often do, consist of highly technical and novel technologies and processes. Whilst expert reports can go some way to set out in more easily-digestible terms what the nature of these technicalities are, in instances where there are competing expert reports it is unreasonable to expect every member of the judiciary to be able to grapple with these technicalities. One key benefit arbitration offers is the ability to assign expert arbitrators to the arbitral tribunal, who have an understanding of this field and who may even not be a lawyer. 

Flexibility

Arbitration further offers the opportunity to tailor the procedure to the needs of the parties in any given dispute. In a similar fashion to the issues discussed above, as crypto is a rapidly-developing technology, the current standard arbitration rules may benefit from being tailored to accommodate the technical nature of these disputes.

Confidentiality

One of the principal characteristics of crypto and blockchain interactions is pseudonymity and anonymity. Accordingly, as and when disputes within the crypto sphere arise, many may be keen to seek out methods of dispute resolution which hold true to this. Arbitration offers the ability to have disputes dealt with confidentially.

On-Chain 

On-chain arbitration refers to arbitration that utilises smart contracts that automate all or some of the arbitral process, with this typically being recorded on the blockchain or other distributed ledger technology. A smart legal contract was considered by the Law Commission in its 2021 paper “Smart Legal Contracts: Advice to Government”, which is defined as a binding contract in which some or all of the contractual obligations are defined in, or performed automatically by, a computer programme. 

In practice, on-chain arbitration can take many different forms. Perhaps the most simplistic iteration of on-chain arbitration is the enforcement of an off-chain arbitral award through applications and systems that facilitate full-scale arbitration processes on the blockchain. Some different types of on-chain processes include: 

Multi-Signature Transaction

Whilst this is by definition not a strict arbitral process, it holds similarities to that of an Escrow account. In short, for a transaction or command to take place, it will require two or more keys that access the wallet to approve the transaction. In normal circumstances, those party to the trade can grant permission without the need for a neutral third party. However, in instances where there is a dispute, a neutral third party will hold a key themselves and can adjudicate on the dispute and decide whether the transaction should take place. 

Oracles

This also is not strictly arbitration. It involves checking a narrow data set with the aim of resolving the dispute. To put this into a practical illustration, where a dispute arises as to whether a certain amount of Bitcoin has been received into a given wallet, checks can be carried out on the blockchain ledger for the specific sending and receiving wallets to determine whether the correct amount of Bitcoin has been transferred. 

Applications

There is now an increasing number of bespoke applications that offer a whole host of arbitration services. Quite often this will involve parties opting-in by incorporating specific code into their contract, which automatically refers a dispute to the platform for resolution. Thereafter, an automatic freeze will pause any transaction pending outcome of the dispute resolution. The parties will select the number of arbitrators and specifically who to appoint to the tribunal panel. Once the dispute has been resolved, there can be an instant on-chain enforcement of the award. 

Automatic Dispute Resolution

This is an end-to-end resolution process that will not only take a view on the dispute but will also implement the decision on the blockchain thereafter. There are many ways in which a smart contract can determine the resolution of the dispute. It will often involve the application of game theory, crowdsourced self-selecting juror decision making, artificial intelligence and appeal or de novo re-hearing procedures. 

On-Chain Pros and Cons

There are pros and cons to adopting on-chain arbitration. One will need to be mindful of them and give full consideration to them prior to engaging in these processes. 

In April 2021, the UK Jurisdictional Taskforce of the Lawtech Delivery Panel published the Digital Dispute Resolution Rules (DDR). The DDR gave powers for the tribunal of appointed arbitrators and/or experts to “operate, modify, sign or cancel any digital asset relevant to the dispute”. This is a significant increase in the powers possessed by the tribunal in respect of enforcing an award, as compared to its traditional off-chain counterpart. In practice, this allows the tribunal to directly affect the enforcement of an award on the blockchain and circumvents many of the issues often encountered when seeking to enforce an arbitral award. 

That said, this increase in power must be balanced carefully. As it currently stands, there is understanding that an enforcement should be put on hold in order to allow adequate time for an appeal against the award to take place. Should a challenge be brought under Section 67 of the Arbitration Act 1996 (substantive jurisdiction) or Section 68 (serious irregularity), there is no rule in default to say the enforcement should be stayed pending determination of the challenge. Furthermore, the normal course of relief pursuant to CPR 62.18(9) (to apply to set aside an order made to enforce an award under s.66 Arbitration Act) and CPR 83.7 (to stay enforcement of an award when converted to a judgment) is not available where tribunal enforcement has occurred under the Rules. 

On-chain arbitration also has the benefit of a tribunal having complete discretion over the procedures to be adopted, the admission of evidence (and in what format), the format of the hearing and the form of the submissions. This allows the parties to streamline the process where it is appropriate to do so and, coupled with (in some circumstances) near instantaneous enforcement of the award, results in an efficient and cost-effective form of ADR. The DDR are designed to be simplistic in nature, requiring a decision to be issued within 30 days from the date of the appointment of the tribunal. 

Similar to off-chain arbitration, on-chain processes also allow for a degree of anonymity. However, it would not be appropriate for complete anonymity to take place as it is necessary to be able to reasonably identify the parties for, at the very least, service of documents and ensuring correct enforcement. This, in turn, causes some difficulties in circumstances where decentralised autonomous organisations (DAOs) seek to implement arbitral procedures by way of smart contracts. It will need to be determined on a case-by-case basis who is to be the figure head representative. 

It must again be stressed that one must consider the drawbacks to on-chain mediation before engaging in the process. Under the DDR, although a tribunal is granted the powers to operate, modify, sign or cancel any digital asset, in practice this will require the parties willingly providing/disclosing their private key to the tribunal. In circumstances where pseudonymity and anonymity are of great importance, there may well be some reluctance to do this.

Syedur Rahman C 09551

Syedur Rahman

Partner

syedur.rahman@rahmanravelli.co.uk
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Syedur Rahman is known for his in-depth experience of serious fraud, white-collar crime and serious crime cases, as well as his expertise in worldwide asset tracing and recovery, international arbitration, civil recovery, cryptocurrency and high-stakes commercial disputes.


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Rhys Evans

Associate Solicitor

rhys.evans@rahmanravelli.co.uk
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Rhys works on major criminal and regulatory investigations, high-level commercial litigation and worldwide asset tracing and recovery for companies and private clients.

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