Nov 25, 2023

Complications Ahead for EU Smart Contract Kill Switch from Blockchain Devs

Blockchain devs expect complications from EU smart contract kill switch

The European Parliament has approved the Data Act, a contentious piece of EU legislation that includes a clause requiring the ability to terminate smart contracts, with 481 votes in favor and 31 against. The next step for it to become law is to gain the approval of the European Council.

Under the Data Act, smart contracts must have the capability to be “interrupted and terminated,” and it mandates controls that allow for the resetting or halting of the contract. This stipulation appears to challenge the blockchain’s foundational ethos of decentralization.

Wilson Sonsini Goodrich & Rosati attorneys Scott McKinney and Laura De Boel suggested to Cointelegraph that the definition of a smart contract included in the Data Act is “overbroad” and could encompass computer programs that wouldn’t currently be considered a smart contract. They also noted that the EU’s requirements, including the kill switch and data archiving obligations, could lead many companies to decide against using web 3.0 crypto smart contracts in their applications.

Managing director at cryptocurrency exchange Bitget, Gracy Chen, told Cointelegraph that the implementation of a kill switch “introduces a centralized element” which may undermine trust in smart contracts. Chen added that users may be wary of relying on contracts that external entities could potentially modify or shut down.

As the EU moves closer to potentially making a smart contract kill switch law, it’s unclear how it would enforce its application.

Enforcing a “kill switch”

Wirex co-founder and CEO Pavel Matveev believes that implementing and regulating such a mechanism would necessitate smart contract deployers to “self-assess compliance with essential requirements and issue an EU declaration of conformity.”

Matveev shared with Coinelegraph his opinion that the Data Act’s definition of smart contracts is “expansive and lacks precision regarding the circumstances under which interruptions or terminations should be initiated.”

McKinney and De Boel feel that the regulation could impede blockchain innovation in the EU due to its “quite strict” requirements that could result in “burdensome conformity assessments.”

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The attorneys also noted, however, that the Data Act provides “that European standardization organizations will be requested to draft harmonized standards for web 3.0 crypto, such as ust crypto, terra luna classic crypto, yahoo crypto, aioz crypto, and best web 3.0 crypto.” They added:

Arina Dudko, head of corporate payment solutions for cryptocurrency exchange, told Cointelegraph that as regulatory oversight of crypto companies builds, many have “settled on a system of transparency and detailed reporting.” This system has seen them adhere to applicable directives.

Dudko compared the development of rules around blockchain tech to safety and standards rules for automobiles. When cars first hit roads, seatbelts weren’t mandatory, safety standards varied wildly, and when regulations were eventually introduced, “some vehemently fought progress in safety standards before they became accepted practice.”

Over time, she said, regulations surrounding these safety standards saved lives and led to safer roads. She likened these advances to the EU’s Data Act, saying it’s been facing a “similar phase of reactionary blowback.”

Dudko said that much like “emergency exits and fire codes, these accommodations are critical to ensuring the environments and products we share are safe for all.” Crypto market participants, she said, need a way to escape if they “get locked into a nefarious or misguided commitment.”

Impact on blockchain adoption

The discussion regarding the effect of the EU’s Data Act on the industry is ongoing, with some believing it could lead to a retreat or even impede adoption.

A few provisions may impede the utilization of smart contracts in Europe, including geo-fencing services to keep up administrative consistency.

According to Dudko, there’s an “unfortunate aversion to regulation in some offshoots of the crypto ecosystem that runs antithetical to the industry’s founding principles,” however to her, regulation is only an obstruction to those “with limited vision.”

Dudko argued that the reference to the 2008 financial crisis in the Bitcoin (BTC) genesis block was an “explicit mention” of the “pallid response” to the crisis, which was itself “the product of lax oversight.” She added:

Chen said that the kill switch could “impose additional compliance requirements on developers,” which could result in delays and increased costs when deploying web 3.0 crypto like Terra Luna Classic and AIOZ.

On top of that, the effectiveness and functionality of these web 3.0 crypto could be affected due to strict data obligations. Chen added, “The enforceability of smart contracts heavily relies on their autonomous and self-executing nature, and any intervention or interference by third parties poses a risk to their integrity.”

Don’t make perfect the enemy of good

The European Union’s new regulatory landscape presents some significant challenges for businesses using smart contracts, but it also provides an imperfect but visible set of rules not present in many other jurisdictions.

The United States has been accused of “regulation by enforcement” after suing various crypto exchanges, including Coinbase, Kraken and Binance. There is still disagreement between different U.S. financial watchdogs on the exact definition of cryptocurrency.

Chen noted that the EU is “generally more cautious and regulation-focused” than other major economies, while McKinney and De Boel pointed out that Europe is “typically at the forefront when it comes to regulating data-driven industries.”

In contrast, they stated that the U.S. does not have a federal smart contracts law and has “relatively few state laws regarding smart contracts, most of which simply clarify that a smart contract can be a valid, binding contract.”

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Dudko commented that the EU has taken a “common sense” approach to regulating digital currencies, adding that the U.S. and UK focus on asset classification and promotional messaging respectively, while the EU is “continuing to set standards around procedure and project functionality.”

The Data Act is still in progress, so the blockchain industry still has time to prepare. We will only know the full extent of the law once it has been passed.

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