Legal assessments of applicability of blockchain and smart contracts in the letter of credit

Letter of Credit is a method that has been used for many years in order to make the payment between the parties safely in the trade. Although different sources contain different information about the emergence of the letter of credit, it is accepted that the letter of credit was started to be used to provide assurance among traders in the thirteenth century in today's sense. In today's sense, the letter of credit can be defined as a bank commitment to pay the contract price, in the most general sense. In the letter of credit, which is generally preferred in international trade, the bank becomes under an obligation to pay the contract price upon the submission of predetermined documents. Letter of Credit is a banking product used to establish trust between the parties to the trade and in this sense, it is considered to be the safest payment method in international trade. International trade, by its very nature, carries a number of risks. The buyer faces the risk of not getting the goods subject to the contract as agreed in the contract or at all; similarly, the seller faces the risk of not getting the price agreed in the contract. Due to the location of the banks in the letter of credit payment method, the risks of the parties are greatly reduced. Because the seller knows that he/she will receive the payment if he/she fulfills the conditions, and the buyer is sure that the seller will not be able to get the price of the goods subject to the contract without meeting the conditions stipulated in the contract. The letter of credit has not remained the same in its historical adventure and has undergone various changes. The letter of credit, which was initially sent by mail, started to be sent by telegram over time, and it became widespread to send the letter of credit through various telecommunication tools with the developments in technology. One of the biggest developments in this sense is the establishment of SWIFT messaging system to ensure communication between banks. In this way, it is aimed to accelerate the letter of credit process. However, a letter of credit is completed in periods ranging from ten to fifteen days on average. Despite the benefits of the letter of credit in international trade, the rate of preference in commercial life is gradually decreasing. The main reasons for this situation are that the letter of credit contains a high level of bureaucratic processes and therefore the transactions take a long time, the high costs, the heavy processing of the physical document review processes, and the difficulties in ensuring coordination between the parties. It is also difficult to say that the fraudulent behavior of the parties can be prevented completely in the current letter of credit application. It is thought that these problems in the letter of credit can be overcome with technology. Indeed, developments in the field of technology are promising in reducing the risks of the letter of credit. Within the scope of our study, the application of blockchain and smart contracts, which are among these technologies, in letter of credit transactions is examined from a legal perspective. There is no agreed definition on the blockchain. In general terms, the blockchain can be explained as a system in which blocks containing a large number of data are encrypted by cryptographic methods and connected one to another. Blockchain is essentially a database. However, the technical infrastructure of the blockchain allows much more complex applications to be constructed beyond being a database. In this sense, smart contracts working through the blockchain are computer programs that enable the automatic execution of the result if the predetermined conditions are met. In fact, it is not necessary to use blockchain technology for the operation of the smart contract. However, thanks to the resistance of the blockchain to change, its decentralized structure, transparency and reliability, the construction of smart contracts in the blockchain infrastructure adds a separate value to smart contracts. In some cases, the word "contract" in the smart contract statement can be misleading. Essentially, these computer codes allow for the mutual exchange of goods and values, as well as a mutual exchange is not required in every case. Whether a computer code can be a contract in the legal sense should be evaluated separately in each case. With the inclusion of the blockchain in the letter of credit process and the use of smart contracts in the process, it is thought that the letter of credit relationship can be built over the blockchain, and the transactions in the letter of credit process will be automated by converting the letter of credit contract into a code. This model aims to digitize the process that works on paper in general, to automate the process and to facilitate the follow-up of the process. In this way, it is expected that the problems experienced in the letter of credit process will be eliminated to a large extent. For example, it is stated that thanks to the instant and transparent sharing of the transactions made in the blockchain with those in the network, all participants can easily follow the transactions, thus the coordination between the parties will be provided much faster, and the costs and risks arising from the late transmission of messages will be reduced. However, at this point, the extent to which the basic features of the blockchain and smart contracts are suitable for the structure of the letter of credit should be examined separately. Likewise, while the inalterability of the blockchain is accepted as a feature that adds value to the process in terms of security, the inalterability of legal transactions may also have undesirable consequences in some cases. The first question to be answered regarding the blockchain-based smart letter of credit model is undoubtedly whether the smart letter of credit contract established over the blockchain can be considered as a legally valid contract. As there is no multilateral international agreement on the letter of credit, there is no regulation in the domestic law of almost any country except the United States. However, the rules published by the International Chamber of Commerce (ICC) regarding the implementation of the letter of credit and aimed at the uniformization of the letter of credit process are shown among the legal sources of the letter of credit. These rules are not directly applicable, they only apply if the parties refer to the contractual relationship. In addition, in order for these rules to be binding on the parties, they should not contradict the mandatory provisions of the applicable law. In this sense, while examining whether the blockchain-based smart letter of credit contract is legally valid, the rules published by the ICC should be taken into account together with the relevant rules of the applicable law. Within the framework of the current regulations, once it is determined that the letter of credit agreement can be established through the blockchain, it should be emphasized how the stages in the letter of credit process will be constructed through the blockchain. In this sense, opening the letter of credit through the blockchain, submitting and examining the documents, paying the amount of the letter of credit should be examined separately. In the blockchain-based letter of credit agreement, one of the most discussed issues is the electronic exchange of documents. It is not accepted to share the data only electronically in the banking legislation of many states, especially in our country, where the Continental Europe legal system is valid. In addition, the retention of documents for a certain period of time is stipulated as an obligation for banks. In this context, in order to implement the blockchain-based letter of credit model, it is essential for states to take concrete steps in their domestic laws to move away from traditional paper-based trade and move towards paperless trade. A blockchain-based smart letter of credit contract, in which all stages operate flawlessly, will undoubtedly not come before the judiciary, so the legal validity of the transaction will not be discussed. However, unpredictable situations can always occur in commercial life. In such cases, in the event of a dispute relating to the letter of credit transaction, the event will be brought to trial and discussion will begin as to whether the transaction is valid or not. In this thesis, whether blockchain and smart contract technologies have the power to create a paradigm change in the letter of credit process is examined from a legal perspective and the legal consequences of applying these technologies to the letter of credit are discussed. In this context, the promises of the blockchain model and the obstacles in front of it are given together in the letter of credit. It is explained which type of blockchain network and which reconciliation mechanisms will be appropriate for the blockchain-based smart letter of credit model, and the legal validity of the blockchain model is gradually examined in the letter of credit. In doing so, the existing legal regulations are taken into consideration and it is evaluated whether the legal basis is ready for implementation. Alternative methods are proposed where the present embodiments are not sufficient.