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Italy defines "distributed ledger technology" and "smart contract"

Article 8-ter of Law no. 12/2019 provides the first legal definitions

26 September 2019

Although there are many issues yet to be clarified, the legislative instrument shows Italy's intention to recognise DLT and smart contracts as legal (and lawful) instruments to boost the digitalisation of the economy.

With the entry into force of Article 8-ter of Law no. 12/2019, the Italian Parliament has provided legislative definitions of "Distributed Ledger Technologies" ("DLTs") (in Italian "tecnologie basate su registri distribuiti") and "Smart Contracts" ("SCs").

Although both the definitions refer to technical standards which are yet to be released by the competent authority ("Agenzia per l'Italia digitale", "AGID", Agency for Digital Italy), Law no. 12/2019 represents the first attempt by the Italian legislator to address the legal nature of DLTs and SCs and their applications.

The definition of Distributed Ledger Technologies (DLTs)

DLTs are defined as "technologies and informatic protocols which use a ledger which is shared, distributed, replicable, simultaneously accessible, architecturally decentralised with cryptography, insomuch as it enables the registration, the validation, the update and the storage of data, both unencrypted and further encrypted, verifiable by each participant, not alterable nor changeable" (art. 8-ter par. 1).

The uploading of a file in a DLT has "the legal effect of the electronic time stamp pursuant to article 41 of Regulation (EU) no. 910/2014" (art. 8-ter par. 3), provided that the DLTs meet the technical standards which will be released by the AGID (art. 8-ter par. 4).

The key elements of the definition rely on:

  • the nature of the ledger (shared, distributed, replicable, simultaneously accessible, architecturally decentralised);
  •  the actions to be enabled by the ledger (registration, validation, update and storage); and
  • the nature of the data (verifiable by each participant, not alterable nor changeable).

The definition is construed broadly in order to include, in principle, all the DLTs currently offered in the market (i.e., private/consortium, and permissioned or permissionless). In any case, to fall within the definition of DLTs, the technology must ensure that data is "not alterable nor changeable." Commentators consider that this requirement, if literally interpreted, will never be met, since no DLTs will ensure a 100% non-alterability of data; therefore it should be expected that the requirement will be interpreted with a reasonability standard, i.e. data should be "[reasonably] not alterable nor changeable." But, even if interpreted this way, the requirement could cause some implementation difficulties: on the one hand, permissioned DLTs (private and consortium) can ensure non-alterability thanks to a "barrier to entry" of the permission which gives some form of control. However, this could conflict with the statutory requirement that the ledger should be "architecturally decentralised". On the other hand, the permissionless DLTs (such as the famous Bitcoin blockchain) can ensure (again, reasonably) that data are not alterable nor changeable only with a consistent number of participants (the "block" in the blockchain) in the same DLTs. Oddly, this number (or an equivalent thresholds) is not present in the recently issued law nor is referred to the AGID's guidelines; in other words, we do not know how distributed DLTs must be to meet a DLT threshold according to Law no. 12/2019. Therefore, it will be a matter of interpretation on a case-by-case basis.

The definition of Smart Contracts (SCs)

An SC is "a computer program which operates with distributed ledger technologies and the performance of which binds automatically two or more parties according to effects predetermined by the same parties. The smart contracts fulfil the requirement of the written form subject to previous informatic identification of the parties involved". Such an informatic identification must meet the technical requirement which will be set forth by the AGID (art. 8-ter par. 2).

Firstly, Law no. 12/2019 sets out a basic requirement: although from a technical standpoint SCs  can also run on technologies other than DLTs (as previously defined), only the ones which operate with DLTs will be "Smart Contracts".

It is unclear whether SCs are considered to fall within the definition of "contracts" according to Italian civil law. While art. 8-ter par. 2 defines SCs as "computer programs", the effects described in that article can lead to an interpretation of SCs either as an execution tool of a pre-existing contract (performance) or a contract within the strictest, civil law meaning (binding nature for the parties).

According to the national council of the notary public (Consiglio Nazionale del Notariato, the board representing notaries in Italy) the technical features of SCs in general prevent that SCs can in principle fulfil the essential elements of a contract under Italian law, given that SCs per se are essentially construed by prescriptive / executive rules. From a technical standpoint, therefore, there is no room for a descriptive section where the parties can agree the legal justification of the agreement (in Italian "causa," i.e. the rationale underlying a transaction), which is one of the mandatory requirements to which the validity of a contract is subject. For instance, a SC can perform a payment between the parties (automatically upon the occurrence of a given circumstance), but the legal ground of such a payment is not contained (nor "containable") in the SC and, therefore, it would not be possible to refer that payment to a loan, a compensation, a penalty, royalties etc.

The national council of the notary public concludes that either SCs are the mere executive tool to perform a pre-existing agreement (which is the contract) expressing the legal justification of the actions performed by means of the SC or the legal justification of the agreement between the parties should in some way be expressed within the SC, e.g. by the inclusion of a descriptive part, useless from a technical standpoint but necessary to express the legal justification of the agreement; or through the standardisation of SCs in one form for each kind of agreement.  

KEY TAKE-AWAY POINTS
  • DLTs and SCs must meet certain technical standards, which the competent authority AGID will issue in future.
  • DLTs require data to be unalterable and unchangeable: requirements that are potentially impossible to meet.
  • The uploading of files in DLTs will have the legal effect of the electronic time stamp pursuant art. 41 of Reg. (EU) 910/2014.
  • Only SCs operating with DLTs are "Smart Contracts" according to law no. 12/2019.
  • It is still unclear whether SCs fall (or will fall) within the definition of contracts under Italian civil law or whether SCs will merely become the tools for the (digital) performance of a (traditional) contract.