Our modern society knows contracts in different forms. If you buy a chewing gum at a kiosk, you have already entered into a contract with the merchant. The superficial aspect is the exchange of the money for the goods, but from the perspective of the law, there are a lot of factors at play that we don't even consider in such everyday actions.
From a lawyer's perspective, a lot of additional information could be provided about the purchase. For example, whether the seller is liable to the buyer for personal injury, and if so, under what conditions. Also, most merchants are likely to have enjoyed at least some theory on such topics during their education. In the context of everyday actions, the whole thing doesn't matter, yet these contractual relationships take on an immediate effect as soon as the everyday framework is left behind.
What if the chewing gum was no longer durable and the buyer fell ill after eating it?
Our example illustrates the importance of contracts on both a small and a large scale. And that is why today's article is of particular importance, because we are dealing with contracts whose content and validity are guaranteed by blockchain technology.
What is a smart contract?
A smart contract is a piece of code that can contain any agreement and ensure that it is enforced. One of the most common contracts of this type is used in ICOs. Typically, the contract specifies who will receive the tokens for sale and when they will effectively be paid out. In this context, most of our readers have probably already interacted with a smart contract.
In principle, a smart contract has no limit to its content or scope. In practice, however, it is always linked to the blockchain on which it is programmed and brought to execution. Depending on how flexible a particular blockchain is, the smart contract may actually interact with objects or facts outside the blockchain.
For example, a smart contract could trigger automated payments once a service is deemed to have been performed. Either the recipient has to manually confirm that the service has been provided or it is even possible automatically because the smart contract can monitor the provision itself. Most agreements are based on an if-then rule. One of the advantages of smart contracts is their transparency and the fact that they execute the agreement in a completely neutral way. Therefore, all parties involved can rely on the fact that no one will modify an agreement or fail to comply with it.
Smart contracts are the second major and promising use case of blockchain technology after payment processing through cryptocurrencies. The first and so far most successful technology that introduced smart contracts is Ethereum.
Disadvantages of Smart Contracts
Although smart contracts can solve a lot of problems, not all aspects of the technology are completely unproblematic. After all, many of these contracts cannot be rewritten. Depending on the parameters, they are very rigid constructs that cannot be adjusted. In principle, this problem can be solved by formulating them flexibly from the outset, but overlook a variable and you are locked in.
A much larger debate can be had about the legal status of such agreements. Many proponents believe that the code of smart contracts simply conforms to or supersedes the law. But actual lawmakers admittedly see it differently. You can define all the terms yourself, but what if they violate otherwise applicable law? The smart contract would then continuously break the law, and once set in motion, nothing could stop it. The disruptive potential of the technology finds its limits here.
After all, contracting parties do not usually want their agreement to violate the law; in most cases, they want to perpetuate a relationship with each other that already exists legally on the blockchain. Thus, criminal offenses are not necessarily the problem, but civil disputes. For instance, how should existing smart contracts be dealt with that end up violating the state-guaranteed rights of one party?
Another aspect that is also closely related to smart contracts is the legal status of a decentralized autonomous organization. In principle, smart contracts can be used to set up an institution that conducts business independently and only on the basis of the contractual rules. But who represents such an organization in court? How can it be addressed in the event of a dispute, and if it were obliged to pay compensation, for example, how would it be enforced?
The fact that smart contracts aim to revolutionize a fundamentally important component of our social interaction simultaneously makes them vulnerable to a number of problems triggered by their absolute structure.
Ultimately, there remains one problem and that is a flaw in the code or an undetected gap that makes it possible to exploit, circumvent or otherwise cause damage to the smart contract. In 2016, for example, the so-called DAO hack enabled the theft of $50 million. As a result, this led to a rift in the community over how to deal with the event in the aftermath. Thus, Ethereum Classic was born and split off from Ethereum.
Use cases of smart contracts
Most use cases that are being tested circumvent the legal problems described by focusing on solutions that automate certain aspects of already existing agreements. Examples include the energy market, payment between machines that autonomously perform tasks, or other billing systems.
For example, there have been initial tests of vehicles that automatically settle fuel filled up with the gas station. Here, the smart contract monitors the amount of fuel delivered and then invoices it. If the other party transfers the required amount, the agreement is deemed to have been fulfilled. Although such examples in essence depict very simple relationships between the parties, they are nevertheless very complex.
In practice, what is at stake here is the integrity of the data that must serve as the basis and the reliability in the execution of the contract. Therefore, most of the use cases are in the field of industry and the automation of manufacturing or billing processes. The reliability of smart contracts makes it unnecessary to deploy personnel to perform the activity themselves, and because they perform the tasks faithfully to the parameters, they do not need to be constantly checked.
Which blockchains support smart contracts?
Ethereum is known for its capacity for smart contracts and is therefore the quintessential example. But the Ethereum blockchain is not the only one capable of implementing protocol-level agreements. EOS, NEO or Polkadot, for example, are among them.
In principle, even Bitcoin is able to define terms for a contract through its script language. However, this is extremely limited and therefore offers hardly any possibilities to serve the use cases we have already discussed.
Ethereum itself -to stick with the example -enables smart contracts through the "Ethereum Virtual Machine" or EVM for short. At its core, this is a decentralized computer that enables the programming and executions of the smart contracts. The EVM is thus the core and guarantees the correct execution of all contracts and writes the results to the blockchain to make them tamper-proof.
To date, Ethereum has created the most secure and largest ecosystem for smart contracts. Over time, more and more challengers came along to create reference to various features an improvement over Ethereum. Many of them have been media-tagged as "Ethereum killers." Although each blockchain technology has its merits, there has been no challenger that has been able to live up to this title.
What future do smart contracts have?
The agreements have a wonderful future because, as already mentioned, they can play a special role for entire industries. But they are not only in demand there; they also have a special significance in the field of decentralized finance.
Ultimately, all achievements in the DeFi sector are based on smart contracts and would not be enforceable without them. Bitcoin was the first time a private, decentralized, public, and censorship-resistant money was introduced to the market. DeFi marks the beginning of an entirely new era. While people were still convinced that banks could be made superfluous when Bitcoin was invented, DeFi has actually made them so.
Taking out a loan, lending money, trading leveraged products or options, all this already takes place in a decentralized manner and will continue to grow. The main problem to be solved is not improvements to the smart contracts, although these will of course also be developed further.
Instead, it will be a matter of ensuring that more people can use the corresponding products at the same time and thus increasing the transaction throughput and stability of the blockchain technology. Once we reach the point where the products become mass-marketable, then there is no reason to rely on middlemen anymore.
Smart contracts are therefore an important part of the foundation needed for this revolution and are an indispensable component. Another aspect is the idea of making the various protocols and thus ultimately also the smart contracts interoperable. This means that in the future it should no longer be the most important thing on which platform a smart contract runs. By finding a way for the various protocols to communicate and exchange information securely with each other, a major problem is thus eliminated.
Only if the development of blockchain technology becomes independent of a specific platform will it be able to succeed as a whole. In the end, it will be a matter of finding the best blockchain for the particular use case without losing comptability with others that can achieve excellent results in their respective fields.