In recent years, there has been widespread use of blockchain-based smart contracts in various financial and property sectors. By greatly simplifying the economic turnover, the potential efficiency and profitability arise from the fact that smart contracts use software to perform certain tasks through automated processes, minimizing the involvement of intermediaries and, therefore, significantly reducing transaction costs. The wide distribution of new technologies always gives rise to various problems, and legislation is often not adapted to the pace of socio-economic changes in the state. Despite the positive side of such technological development, the consequences may entail certain dangers for the participants in this kind of relationship. The absence of the very concept of smart contracts in the legislation of most states gives rise to undoubted difficulties in determining their legal essence. This article examines the current state of smart contracts in Malaysia, examines the viability of the Malaysian legal framework in relation to the practice of using smart contracts and blockchain technology, and analyzes the legislative acts and policy documents in force in Malaysia.
The potential efficiency of using smart contracts arises from the fact that this process uses software to perform certain tasks related to the contract through automated processes. Indeed, for contracting parties, automation can help reduce time and cost. Of course, automation itself is not a new concept. Automated processes and services pervade much of modern life, from automation in the manufacturing industry to online banking or even mundane examples like the use of vending machines. However, at present, legal contracts are generally not automated and require human input to formulate, conclude, execute, and enforce their obligations. Such processes are time and resource consuming. Therefore, automating some or all of these processes can be beneficial.
The term “smart contract” was first coined by Nick Szabo in the mid-1990s. However, smart contract flavors such as transaction processing systems for daily payments and receipts for financial institutions using computers have been around for decades.
Smart contracts are “user-defined programs that follow the rules governing transactions.”
A smart contract consists of program code, storage file, and account balance. Usually, a user can create a contract by placing a transaction on the blockchain, although not all blockchains support smart contracts. The contract program code is fixed when the contract is created and cannot be changed.
Smart contracts can be especially effective for sectors that use highly standardized contractual terms without significant deviations. Smart contracts can also benefit society as a whole by reducing public or private sector costs or litigation. In addition, smart contracts can give rise to other benefits, such as making it easier to enter into contracts without the use of an intermediary, or easier verification of identity, or the execution and recording of transactions (for example, when paying for an automated highway). Smart contracts can also facilitate the use of electronic signatures, increase contract transparency, and reduce disputes by automatically enforcing rights (and thus eliminating the need to remind the other contracting party to fulfill its obligation).
Blockchain technology is gaining momentum and is being applied in many sectors of countries around the world. In the literature related to blockchain technology, different concepts and definitions are often used. While many of these definitions are purely technical in nature, some of them are fundamental to understanding blockchain technology. It is pertinent to mention here that the International Organization for Standardization established the Technical Committee on Blockchain and Distributed Ledger Technologies (ISO / TC 307) in 2017 in order to bring blockchain technology to the next level, that is, from revolutionary financial transactions to improve the efficiency of the public sector, healthcare, and business areas.
Malaysia has seen a clear increase in the use of blockchain technology and smart contracts. According to International Data Corp. (IDC), Malaysia spent $ 17.57 billion on technology in 2018, of which 50% is in telecommunications.
Moreover, it is projected that by 2021 the gross domestic product (GDP) in Malaysia will be digitized by at least 20%.
The Malaysian government is actively working on various initiatives aimed at achieving the goals set in the Vision 2020 program, including technological ones.
In addition, it adopted the National Roadmap for Transformation — 2050, in order to prepare citizens for the fourth industrial revolution. Malaysia’s Eleventh Plan (2016–2020) provides the foundation for Malaysia’s transition to a developed economy and inclusive nation, driven by information and telecommunications technologies in the Knowledge Economy.
The Eleventh Plan aims to ensure digital accessibility and transform the economy to become more knowledge-driven by expanding broadband infrastructure to 95% of communities.
Strategic Focus Five underlines the need to strengthen infrastructure to support economic growth in order to improve connectivity and the integration of urban services through smart city development. How blockchain technology works can help governments provide better connectivity.
The Malaysian government has already taken a number of initiatives in the area of automation and smart city construction. The Malaysian Communications and Multimedia Commission approved the Smart Cities Standardization Framework for Information and Communication Aspects developed by the Malaysian Technical Standards Forum Internet Working Group.
Government policies and initiatives, along with its commitment to sustainable and inclusive development, in line with the government’s commitment to implementing the 2030 Agenda for Sustainable Development, are driving the application of blockchain technology in Malaysia. Blockchain technology could also be a useful tool for the Malaysian government in its quest for automation in various service sectors and building smart cities.
Blockchain, the way data is structured, is more than just a decentralized database.
It is the first technology to provide distributed consensus on the state of a distributed ledger of transactions, allowing, among other things, the creation of the first trustless distributed currency. It can be thought of as the “internet of value.”
Blockchain as a technology is not subject to regulation in Malaysia. However, the various applications based on this technology could be considered for regulation and should ideally not function without some kind of regulatory oversight. The term “regulation” refers to the policies that the government uses to oversee the market activity and behavior of the private sector in the economy.
The relationship between innovation and regulation is complex and dynamic. Regulation has a direct, both positive and negative impact on the innovation process. Conversely, innovation, and technological change have a significant impact on regulation and compliance.
Regulations can be principle-based or outcome-based, where general principles or outcomes will structure the overall regulatory environment and businesses will be empowered to operate as long as they comply with these principles. Regulation can take the form of self-regulation, quasi-regulation, co-regulation, command-and-control regulation, and explicit government regulation. These types of regulations have already been tested against other technologies.
Since blockchain technology is in its early stages, command-and-control regulation may not be appropriate at this time. It appears that industry self-regulation will be the most appropriate form of regulation when industry participants establish their own rules of governance and, therefore, remain accountable to government and stakeholders.
Regulation has a direct impact on innovation. To improve the positive regulatory impact on innovation, without compromising the original regulatory objectives, the Government of Malaysia has been asked to take into account the following:
- regulatory processes should take into account the consequences of technical changes;
- competition between organizations should be increased;
- it is necessary to introduce regulations and simplify them by eliminating duplicate, burdensome and ineffective regulations;
- a technological approach should be considered, taking into account economic instruments, voluntary agreements and their implementation, and not the development of standards;
- legislative provisions should be consistent with international regulations in order to eliminate uncertainties, inefficiencies, and market barriers that can slow down the innovation process.
Blockchain technology is in a phase of development and experimentation. Therefore, it is wise to wait a little longer to accurately predict legal and regulatory issues. However, given its enormous potential, it can be expected to present some unique challenges for regulators.
At the same time, this technology can lead to revolutionary changes in a wide variety of sectors, and therefore, immediate steps must be taken to reap the benefits of this technology. It is in this spirit that the Government of Malaysia and regulators have begun to undertake various initiatives. A special working group was established to study the potential of blockchain, and a Malaysian national committee was formed to participate in the development of the ISO standard (ISO / TC 307) in blockchain and distributed ledger technologies. Malaysia is recognized as a lucrative country for investment and innovation internationally. Although the Malaysian high-tech industry and government group announced that Malaysia will switch to the blockchain by 2025, the government is considering its use at least in sectors such as land registration, halal industry and Islamic technology, fintech. industry.
In recent years, blockchain technology has been used in several non-financial sectors in Malaysia. For example, Malaysia’s Sustainable Energy Administration has adopted blockchain technology and launched a peer-to-peer “P2P” energy trading pilot program. For example, a solar PV power producer sells surplus solar power on an energy trading platform to other consumers. This direction is one of the strategies studied under the Roadmap for the transition to renewable energy sources until 2035, which is aimed at achieving the government’s goal (20% of renewable energy in the national energy supply by 2025), which will facilitate the installation of solar panels on the rooftops of residents.
In addition, blockchain technology has also been used successfully for tagging. The International Islamic University of Malaysia is the first university to use the QR code in education certificates. Thus, certificate authentication can be done by simply scanning it. This process simplifies verification and curbs the growth of the black market for educational certificates.
The nature of blockchain technology, its anonymity, and virtual freedom from any government control can create new opportunities for money laundering and terrorist financing. In order to reduce the risk of using technology for these purposes, any person who carries out activities through digital currency exchange is accountable and subject to the provisions of the Law on Combating Money Laundering and the Financing of Terrorism 2001, Standards and Recommendations on Digital Currencies issued by the Central Bank of Malaysia, in particular the Anti-Money Laundering, Anti-Terrorist Financing and Targeted Financial Sanctions Policy Documents for Certain Non-Financial Businesses and Professions and Non-Bank Financial Institutions (“Policy Document 2020”), which entered into force on January 1, 2020.
The early practice of smart contracts can be traced back to digital vending machines, where a machine accepts coins and uses a simple mechanism to dispense change and merchandise. Smart contracts, on the other hand, are now moving beyond the vending machine, offering their highest potential in a digital transaction using cryptocurrencies and blockchain technology.
In normal transactions involving a sale and purchase agreement, the parties involved usually agree to the terms of the agreement and enter into it with the exchange of the asset and the payment of money. Under common English law, which also governs Sharia-compliant transactions in Malaysia, a traditional contract depends on four main elements. These basic elements are offer, acceptance, purpose, and performance.
A traditional contract can be concluded directly or indirectly. The direct form can be made by personal offer and acceptance (this can be done verbally or using understandable sign language), with some payment in compensation and exchange of goods or assets on the spot. While the indirect form of the contract can be concluded in writing or through the exchange of letters or emails indicating the proposal and acceptance. The agreement itself is considered binding. Unlike a regular transaction, a smart contract in a digital transaction (for example, for a sale and a purchase) has its own complexities.
Nick Szabo explained that “the main idea behind smart contracts is that many types of contractual clauses can be embedded in them (such as liens, binding, delineation of ownership, etc.”).
For example, the hardware and software that we deal with when using a smart contract make it costly for the violator to breach the contract.
There is no precise definition of smart contracts in the current legislation of Malaysia. The National Institute of Standards and Technology of the US Department of Commerce defines a smart contract as a collection of code and data (sometimes called functions and state) that is deployed using cryptographically signed transactions on the blockchain network.
A number of researchers explain how a smart contract works as follows: “Future transactions sent to the blockchain can then send data to publicly available methods offered by the smart contract. The contract executes the appropriate method with user-provided data to perform the service. The code residing on the blockchain is immutable and therefore can be used (among other things) as a trusted third party for financial transactions that are more complex than simply sending funds between accounts. “Before researchers at the National Institute of Standards and Technology, there was a short version of the definition of a smart contract — as “a set of promises, digitally defined, including the protocols in which the parties fulfill those promises.”
Blockchain transactions, resulting from the explosive growth of the Islamic financial services industry in Malaysia, also represent new fintech companies that offer the use of blockchain and smart contracts that comply with Sharia principles. Meanwhile, the position of cryptocurrencies has already received an ambiguous assessment from Muslim scholars. The positions were divided into two main groups. The first group believes that cryptocurrency is banned due to the elements of Gharar (uncertainty) and Maysir (speculation). The second group insists on the admissibility of using cryptocurrency on the basis of makhlah (public interest). This situation does not prevent fintech companies from releasing their own version of the blockchain and smart contracts, which, in their opinion, comply with Sharia law.
In Malaysia, with the establishment of the Shariah Advisory Board at the Central Bank of Malaysia, it has become apparent that members of the Shariah Advisory Board are needed to improve their knowledge of blockchain and smart contracts. These innovations can be viewed as new challenges in rulings in accordance with Sharia principles. Thus, every aspect of the blockchain and smart contract should be carefully considered.
In Malaysia, the Contracts Act 1950 is considered the main law governing smart contracts. It can be argued that this Act is only applicable to traditional contracts. However, no matter how innovative a smart contract is, it must fulfill the essential basic elements to be recognized as valid and legal.
The most important and relevant provisions of the Contracts Act 1950:
Section 10 (1): “All agreements are contracts if they express the free will of the parties entitled to enter into contracts for purposes not contrary to law, and in the absence of grounds for their non-conclusion and invalidity”; section 2 (a): “When one person expresses his will to take any action or refrain from it in order to obtain the consent of another person to take such action/omission, the person is considered to have made an offer to conclude a contract”; Section 5 (1): The offer to conclude a contract can be withdrawn at any time before the expiry of the acceptance period; Section 2 (b): Acceptance is the final and unconditional agreement to enter into a contract.
Moreover, thanks to the existence of blockchain technology, contract data is stored on every computer on the network. Once a smart contract is concluded, it is difficult to abandon its existence. Thus, there are two important parts of a smart contract, namely recorded transactions, and an automated ledger. By agreement of the parties to the coded terms of the contract, you can put your cryptographic signature or digital signature.
The aforementioned provisions of the 1950 Contracts Act must be followed appropriately in the smart contract process. This is important in order to avoid any controversial issues that may lead to litigation by the parties involved in the smart contract.
A study of the existing practice of smart contracts in Malaysia suggests that smart contracts of blockchain technology are more or less similar to traditional contracts. Therefore, the requirements of the Contracts Act 1950 applicable in Malaysia must be properly complied with.
Malaysia’s legal framework can be considered viable and responsive to the challenges of new innovations in blockchain technology and smart contracts. However, it is recommended that the definition of an electronic transaction be expanded to cover smart contracts and blockchain-based transactions. With regard to Sharia compliance for products offered by fintech companies, Malaysian regulators are encouraged to conduct proper scrutiny of their activities, regardless of their interactions with Sharia advisors.
Moreover, no matter how paperless smart contracts are, in order to make a fair decision in the event of a dispute, it is necessary to present material evidence in court or legislatively provide for alternative dispute resolution channels.