Smart Contracts and the Blockchain Economy

The notion of smart contracts is not new or even of this century. The idea was first conceived in the 1990’s by cryptographer and computer scientist Nick Szabo who published a paper called Smart Contracts: Building Blocks for the Digital Economy. He had growing concerns about the compatibility of established traditional legal systems with the inevitable increase of digitalization within society. Szabo stressed the growing influence of digital technologies on our personal lives and relationships could pose a serious threat to the established legal traditions.

 

Computers allow for the efficient processing of complex algorithms, it is now possible to use the advent of these technological innovations to maximize societal welfare and economic well-being. One way Szabo foresaw this happening was through smart contacts. Contracts, after all, allow the functioning of not only virtually all sectors of the economy but can also play a role in the day-to-day dealings of citizens. “Contracts are the basic building block of a free market economy,” the security and enforceability of these contracts is one of the foundations on which human relationships are built. Contracts represent a set of promises that entities concur on in order to formalize a relationship or agreement. Importantly these contracts are not exclusive to the business world. Rather, they encompass many facets of our day to day lives largely going by unnoticed.

Smart Contracts

Smart contracts are described as “far more functional than their inanimate paper-based ancestors. No use of artificial intelligence is implied. A smart contract is a set of promises, specified in digital form, including protocols within which the parties perform on these promises”. The basic premise is to use cryptographic algorithms and messages to ensure the verifiability, observability, privity, and enforceability of contracts. These four objectives are basic principles of contract design that must be adhered to by the protocols.

 

Perhaps, the best explanation of a smart contract was one given by Szabo himself where he compared smart contracts to their primitive ancestors, the vending machine. Ironically, whether you are aware of it or not when you take that lunch break during a busy day at work and pick your favourite snack from the vending machine down the hall you are, in effect entering a contract with the said vending machine. The vending machine takes your payment and then proceeds to dispense your selected item and change in a fair manner. This vending machine has just, in very simplified terms, executed the contract. On the blockchain and between two entities the smart contract would work differently as shown below.

 

The contract is established and written as code into a digital ledger. The interaction between the two parties would be visible to every node on the blockchain however they as individuals would remain anonymous. Once this contract has reached the point of execution it will trigger and execute itself. This, in turn, could have benefit for regulators who would be able to better understand market activity.

 

Enter Blockchain

Projects like Ethereum and Neo have created open-source platforms in order for developers to create Decentralized Applications (DApps) using smart contracts. The blockchain has enabled orders of magnitudes more ways for these smart contracts to now be implemented across various industries and it is inevitable that as blockchain technology matures so will the efficacy and efficiency of smart contracts.

 

As a cryptographer, Szabo recognized the value of cryptographic protocols, in particular, private and public keys. He described cryptographic protocols as being built around a foci of obscurity called keys and it was this obscurity which provided the safety and ensured the foundations of cryptographic protocols.

Blockchain allows for the elimination of any intermediaries that must be relied upon to enforce penalties for breach of contract. The smart contract’s inherently unalterable protocols because of the blockchain ledger’s tamper-evident nature mean that there is little to no reliance on third-parties. A direct result of this are the subsequent cost-efficiencies resulting from the implementation of smart contracts. The elimination of the third party can substantially reduce fees and streamline processes that previously required time and resulted in inefficiencies. The blockchain also facilitates observability by providing a distributed ledger that is viewable to anyone interested as to what exactly they are entering into, thus providing incomparable transparency.

 

Smart Contracts and Initial Coin Offerings

Over $3bn was raised in ICO’s across the cryptocurrency landscape in 2017 alone as shown below. An integral part of any ICO is the efficacy and impenetrability of their smart contract protocols. The need for the auditing of these contracts has become increasingly vital in 2018 with investment in ICO’s increasing at astonishing levels and increased amounts of money at stake.

Smart contract auditors are not nearly as rare as one would expect. In fact there are projects like Solidified that audit ICO’s and smart contracts ensuring that they not only do what they are supposed to, but more importantly that the ether that could be contributed to the project is safe from attacks by hostile parties. Services like these are vital as they not only protect the business itself but may very much help prevent any potential harm that may occur to end users and investors.

 

It is not enough to stress the importance of projects auditing their smart contract protocols. Hacks and breaches of the security parameters of the blockchain can lead to hundreds of millions and in some case billions lost in publicly-funded money. Investors need to begin valuing these audits more and recognizing that any project worth the ETH they are asking for must be properly vetted by auditing professionals.

 

Smart Contracts have had the potential to truly revolutionize the world in which we live in since Nick Szabo himself originally pioneered the idea of the smart contract being the building block for a digital economy. However, now as a result of open-source platforms like Ethereum we have emerging interest from the public as a whole and large amounts of funding is being provided, allowing many developers to go ahead with their plans. If we begin allowing structurally weak tokens to flourish in this nascent industry it could have long-term implications that we have yet to foresee. Cryptocurrencies as a whole are under a close watch from governments and regulatory bodies all over the world. All watching for a careless flaw, a complacent mistake that would result in their intervention. A breach and loss of money could lead to suffocative regulatory oversight that could, in order to protect consumers, smother innovation and prove an obstacle to the mainstream adoption of blockchain and cryptocurrencies as a whole. It is vital that as we start implementing smart contracts into the workings of our everyday lives we emphasize the protection of investors and the blockchain community as a whole.

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3 Comments

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  1. Please see the Agoric papers by Mark S. Miller and K. Eric Drexler . I imagine that Nick was aware of this work, though only he can verify that.

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