Smart Contracts: The rise of computer jurisdiction (Article 10)
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Smart contracts are a necessary topic to discuss when talking about second generation blockchains. However, smart contracts were already introduced in the mid-1990s, so about 15 years prior to the advent of Bitcoin, a first generation blockchain. Nick Szabo, a computer scientist, lawyer and cryptographer, first proposed smart contracts in 1994, and subsequently spent several years advocating for their usefulness. All this predates the founding of Bitcoin, and Szabo remained adamant that smart contracts would be the ideal building blocks for a peer-to-peer digital marketplace. However, without decentralized blockchains, smart contracts could not be implemented as he intended.
Smart contracts are code stored at multiple nodes or on computers and which are executed automatically once specific predetermined conditions are met. The ability to execute the smart contract automatically was not a new invention that was specific to smart contracts, as nearly all computer programs have had this ability for quite a while. The key challenge is enforcing the smart contract execution and preventing any party from altering the pre-agreed conditions. The necessary decentralization that prevents a single entity from changing an agreed smart contract is present in blockchain technology.
As Bitcoin gained popularity and the potential of blockchain became more widely recognized, adding smart contracts to blockchains was a logical next step. The most successful blockchain at the moment that allows smart contracts is Ethereum, and many smart contracts exist on it. As explained in a previous article, Ethereum is more than just a transaction platform; it is rather a sort of decentralized computer where anyone participating in the blockchain can build and use smart contracts. Following Ethereum’s footsteps, Solana, Polkadot, Cardano, Avalanche, Cosmos, Elrond, Ergo, Tron and many other second generation blockchains likewise support smart contracts.
Smart contracts are very promising technology as they allow for the implementation of a number of useful features:
- Automatic enforcement of contracts, so all involved parties have to honour their contractual obligations.
- Ensure trust and transparency between parties since no single entity exerts control over the contract or its enforcement.
- Fast execution: there is no requirement for a third party (e.g. a lawyer) to check and confirm that the conditions are met, or to grant permission for the execution of the contract.
- Increased security, since all contract records are being fully encrypted.
- Reduced costs: there are no fees involved except mining fees, which are much lower than the fees for legal advisors and costs for registering a contract.
Even large enterprises have noted the benefits of blockchains and smart contracts: IBM provides smart contracts commercially. Smart contracts have the potential to aid in a number of areas and applications, including institutional, governmental, medical, electoral and personal record-keeping, agriculture and the supply chain, financial services and payment processors, services related to dispute resolution, as well as areas within technology, such as video games, Internet-of-Things (IoT), Artificial intelligence (AI) and machine learning (ML).
Unfortunately, there are also a number of shortcomings to smart contracts:
- At present, smart contracts are not yet admissible at the court of law. So, unless jurisdictions accept them as fully legally binding and mandatory enforceable contracts, smart contracts will not be enforced if a transfer of physical assets is included.
- Smart contracts are computer code, which makes them difficult for non-technical people to understand. Unless smart contracts are written in a more accessible language that is suitable for laypersons, they will remain a niche and primarily used by programmers.
- A bug in the smart contract’s code can be exploited, which in turn has the potential to result in a loss of funds — this happened in the case of ‘the DAO [Đ]’, which will be covered in detail in a future article.
- Smart contract conditions are generally digital conditions, such as a transfer of funds. But when a physical condition or human judgement is required, the deployment of smart contracts becomes challenging.
Smart contracts that only involve digital assets and/or information are easily implemented and enforced. For example, smart contracts can be used so that dividends on shares or quarterly financial stocks are paid automatically. They can also transfer the ownership of a digital asset from one party to another once the agreed amount of cryptocurrency has been transferred.
On the other hand, when the smart contract relies on external (or ‘off-chain’) data, its implementation becomes more complex and challenging. For example, a smart contract may need to be able to connect with currency exchange rates to determine the payment of interest rate, while a different contract needs to be able to establish the duration of flight delays to calculate passenger compensation. In such situations, the smart contract requires some nodes to establish a connection between the blockchain and the physical world. Such nodes are called ‘oracles’, which is an analogy to the oracles in Greek mythology that enabled the communication between humans and the Gods.
As adding blocks to the blockchain requires a consensus to prove the authenticity of the block; a consensus is also needed to ensure the validity of the information that the oracles feed to the smart contract. It is vital that a system is in place that prevents false data is being fed to the smart contract solely for the benefit of some specific nodes. At present, developers are working on further developing the capabilities of oracles, so that they provide only the appropriate data to smart contracts.
The value of smart contracts within the digital environment has already been demonstrated in numerous ways: they are the building blocks for Dapps (decentralized apps), they are fundamental in the formation of DAOs (Decentralized autonomous organizations), and are also the enabling factor for gameFi and DeFi. Decentralized exchanges and cryptocurrency swapping platforms likewise exist because of smart contracts. These are just smart contracts’ present applications; they still hold vast potential for the future. It can be expected that many further functions and areas of applications will become apparent once a reliable and scalable consensus mechanism for the oracles has been developed.
