Smart Contracts

The concept of smart contracts was first conceived by researcher Nick Szabo in the mid 1990s. In his papers, he described smart contracts as a set of promises, specified in digital form, including protocols within which the parties perform these promises. This description can be broken into four pieces:

• A set of promises
• Digital form
• Protocols for communication and performance
• Performance of actions triggered automatically

As you can see, nowhere in this is the blockchain directly specified, as blockchain technology had not yet been invented and would not be invented for another 13 years. However, with the invention of blockchain technology, smart contracts were suddenly much more achievable.

Smart contracts and blockchain technology are independent ideas. A blockchain can exist without smart contracts (Bitcoin, for instance, has no real smart contract ability...

Why smart contracts?

The world before smart contracts was one that was fraught with uncertainty. Legal contracts, even simple ones, need not be followed, and the cost of recourse using most legal systems was and is extremely expensive, even in countries where the legal system is not corrupt. In many areas of the world, contracts are barely worth the paper they are written on, and are usually enforceable only by parties with substantial political or financial power. For weaker actors in an economic or political system, this is a terrible and unfair set of circumstances.

The issues that we mentioned previously come primarily from the human factor. As long as a person is involved in the enforcement of a contract, they can be corrupt, lazy, misinformed, biased, and so on. A smart contract, in contrast, is written in code, and is meant to execute faithfully no matter what parties are...

Smart contract approaches

One approach to smart contracts is to allow full-featured software to be embedded either inside or alongside a blockchain, able to respond to blockchain events. This is an approach taken by Hyperledger Fabric, Ethereum, NEO, and other such companies. This approach gives maximum flexibility, as there is essentially nothing that cannot be written into the blockchain system. The downside of this power is the risk of making errors. The more options available, the more possible edge cases and permutations that must be tested, and the higher the risk that there will be an undiscovered vulnerability in the code.

The other approach to smart contracts is to greatly reduce the scope of what is possible in return for making things more secure and costly mistakes more difficult. The trade-off is currently flexibility versus security. For instance, in the Stellar...

Limitations of smart contracts

Smart contracts hold tremendous power, but they do have limitations. It is important to note that these systems are only as good as the people building them. So far, many smart contract systems have failed due to unforeseen bugs and events that were not part of the initial design. In many cases, these were merely technical flaws that can at least be fixed in time. However, with the recent rush to use blockchain technology for everything, we are likely to start seeing more substantial failures as people fail to understand the limits of the technology. For blockchain to truly have maximum business impact, both its advantages and limitations have to be addressed.

Data quality and mistakes

Like all...

Summary

Smart contracts are agreements written into code between different parties. The critical aspects of smart contracts is that they contain promises that are in digital form. All of these promises can be executed using digital protocols for communication performance. The outcomes of the contracts are triggered automatically.

At this point, you should have a solid understanding of what smart contracts are, how they work, and their strengths and limitations. You should be able to understand the dangers inherent in smart contract ecosystems and be able to gauge possible risks in the development of smart-contract-based systems. At a minimum, you should recognize the need for careful and thorough evaluation of smart contracts for security reasons. Remember, with smart contracts, the code is executed with little or no human intervention. A mistake in a smart contract means the...