Consider a scenario that’s becoming more common in the cryptocurrency world: A DeFi lending protocol automatically liquidates millions in collateral when Ethereum’s price drops 15% in thirty minutes.
There’s no issue with the smart contract; it went off without a hitch. But the borrower claims the liquidation was premature, arguing that traditional margin requirements would have given them time to add collateral. In return, the lender points to the immutable blockchain record that shows the contract worked as coded.
Who’s right here? And more importantly for your business: what happens when the gap between “the code worked” and “this isn’t what we agreed to” leads to a million-dollar dispute?
Smart contracts can lead to a legal-technical disconnect
As technology, smart contracts are highly sophisticated, but that sophistication isn’t without problems, especially those of a legal nature. The assumption that “code is law” fundamentally misunderstands how legal systems evaluate agreements, and this disconnect is where disputes originate.
There are several issues that crypto businesses are trying to resolve, often in real time.
| Core Issue | Technical Reality | Legal Reality |
| Automated execution during market stress | Smart contracts execute precisely as programmed, triggering liquidations at exact collateralization ratios | Courts evaluate whether automated execution reflects actual agreement, considering circumstances like market volatility and the borrower’s ability to respond |
| Decentralized governance claims | Protocol decisions made through token voting and algorithmic processes | SEC examines who actually influences outcomes, as shown in the BarnBridge DAO settlement, where founders retained effective control |
| Cross-border blockchain transactions | Smart contracts operate identically across all jurisdictions | Courts apply local law and regulations, creating conflicts when automated execution spans multiple legal systems |
| External data dependencies | Third-party oracle services provide price feeds and data sources | Protocol developers face legal responsibility for oracle selection and safeguard implementation |
| Algorithmic investment mechanisms | AMMs and yield protocols operate through automated functions without human intervention | Regulators classify based on economic function; automated investment-like returns may constitute securities regardless of technical decentralization |
These disconnects create predictable legal vulnerabilities; however, the solution isn’t to avoid smart contracts. It’s implementing them within frameworks that address how courts and regulators operate.
How to implement smart contracts to minimize legal risk
Success requires building legal protections into your technical architecture from day one, not retrofitting compliance after deployment. This involves understanding your risk profile, planning your legal frameworks, incorporating dispute resolution mechanisms, and continually addressing risk vectors.
Assess your risk profile before implementation
Before deploying smart contracts, evaluate three key risk factors that determine your legal exposure and implementation approach.
1. Transaction complexity and automation suitability
Smart contracts work best for standardized transactions with clearly defined parameters and predictable outcomes. High-value or complex deals requiring discretionary judgment need hybrid approaches that combine automation with human oversight capabilities. The more subjective evaluation your transactions require, the higher your dispute risk.
2. Regulatory classification risk
The SEC’s 2025 guidance requires specific disclosures for smart contracts, including details of security audits and governance mechanisms. Smart contracts involving securities-like features, cross-border payments, or consumer transactions may trigger licensing requirements or disclosure obligations.
Assess whether your smart contract’s economic function could be classified as a regulated activity.
3. Jurisdictional and enforcement complexity
Cross-border smart contracts raise multi-jurisdictional legal questions, increasing dispute resolution costs and uncertainty in timelines.
Consider whether your implementation spans multiple regulatory regimes and how you’ll handle conflicting legal requirements when automated execution produces disputed results.
Build comprehensive legal frameworks
Create dual-layer documentation that combines smart contracts with traditional legal agreements, explaining elements like:
- Business context
- Key terms not apparent from code review
- Dispute resolution procedures
Providing this insight is important because code-only contracts leave it up to courts to interpret intent and circumstances beyond what the automated execution reveals. For cross-border transactions, establish choice of law clauses and dispute resolution mechanisms before the contract is deployed.
Implement built-in dispute prevention mechanisms
Recent cases like Coinbase v. Suski (2024) demonstrate that courts still have control when determining which terms in inconsistent contracts offered by a particular party are enforceable. This means your smart contract code alone won’t determine legal outcomes; courts will look for additional context to understand what parties actually agreed to.
Build dual-layer documentation that combines your smart contract with traditional legal agreements. Include business context that explains why specific automated triggers exist, define key terms that aren’t obvious from code review, and establish dispute resolution procedures for when automation produces unexpected results.
Without this interpretive framework, courts must guess at your intent when disputes arise.
For cross-border implementations, establish choice of law clauses and dispute resolution mechanisms before deployment. Legal enforcement remains territorial, even when blockchain transactions span multiple jurisdictions, so it is essential to determine upfront which law applies and where disputes will be resolved.
Maintain ongoing risk management
The SEC now requires disclosure of whether smart contracts have undergone third-party security audits, who conducted them, and the results of those audits. To achieve this, establish clear procedures for both technical updates and legal modifications, ensuring changes maintain compliance and don’t create unintended legal consequences.
Additionally, monitor for the high-risk scenarios identified earlier: oracle dependencies, governance centralization points, and cross-chain coordination requirements. The SEC’s shift from aggressive enforcement to structured rulemaking means there may be more transparency around what’s permissible, and more emphasis on proactive risk mitigation than reactionary penalties.
Each category requires specific monitoring and contingency planning appropriate to your implementation.
The path forward requires integration, not replacement
For businesses currently using or considering smart contracts, improvising isn’t a practical path forward. The technical complexity, regulatory developments, and cross-jurisdictional challenges require experienced counsel who understands both the technology and the evolving legal landscape.
Contact The Law Offices of Andrew Dressel LLC to discuss how smart contract disputes could affect your business and develop comprehensive strategies for both prevention and resolution.
The content in this article is for general informational purposes only. It should not be construed as legal advice or a substitute for legal advice. The information above does not create an attorney-client relationship, nor do prior results guarantee future outcomes. Any reliance you place on such information is therefore strictly at your own risk.