Smart contracts: what you need to know

5 June 2020

Blockchain and Artificial Intelligence are topics that get a lot of hype. And so do Smart Contracts. But what really are they? Under which circumstances you can benefit from them? 

Things are more efficient when the need for trusting the other party to execute is removed, we all agree with this statement.

While the term “agreement” can be defined in different ways (and, quite often, such a definition might differ from country to country), one might safely say that an agreement is:

meeting of minds with the understanding and acceptance of reciprocal legal rights and duties as to particular actions or obligations, which the parties intend to exchange; a mutual assent to do or refrain from doing something; a contract.

So, rent agreements stipulate that Peter pays Tricia some money in return for the use of Tricia’s apartment. With car insurance agreements, Chris agrees to repair any damage to Herbert’s car in the future in return for a periodic payment. 

But the point is, how difficult is to enforce an agreement when one of the parties (or all of them) doesn’t fully comply with its clauses? How troublesome can be if Peter interrupts his payments to Tricia, or if Chris refuses to repair Herbert’s car?

That is the reason why smart contracts can be useful tools but, as it always happens, they aren’t a panacea.

What is a Smart Contract?

The difference between a traditional and a smart contract is that in the latter, the conditions of the agreement are both evaluated and executed by computer code. Smart contracts are, therefore, trustless.

Let’s make an example. Cleveland is a carpenter, and Lois wants a new dining table. So Cleveland and Lois agree as follows:

  • Lois pays Cleveland €250 for the dining table
  • Cleveland promises to deliver the dining table to Lois within two weeks.

With smart contracts, the code can determine whether the conditions are met or not (has Lois paid Cleveland? Have two weeks passed from the payment? Has Cleveland delivered the dining table to Lois?). If so, the smart contract can guarantee the execution of the agreement: the parties are unable to back out.

In traditional contracts, each party relies on a third party. This can be the other party (e.g., Lois needs to rely on Cleveland’s promise to deliver the dining table within two weeks from the payment) or a third party, usually lawyers and the judicial system (e.g., Lois can sue Cleveland if he’s unable to deliver the dining table, and rely on the “system” to receive her money back, preferably together with a compensation for her). 

On the contrary, a smart contract executes what is supposed to happen, in a timely and objectively fashion.

How much intelligent are smart contracts?

The execution of the agreed-to consequences is what makes smart contracts powerful. A smart contract can lock a non-paying renter out of his apartment. But smart contracts are not intelligent by their nature. 

In an ideal world, a truly smart contract would act as an excellent judge, taking into account all the extenuating circumstances, looking at the spirit of the agreement and making fair rulings. At least so far, smart contracts follow the rules. Without smearing and without leaving anything to chance, but that’s all smart contracts can do. There is no room for ambiguity, which could be seen as a strength. On several occasions, smart contracts’ rigidity can result in issues

In law, there’s a rule of thumb: the more complex a contract it is, the harder it gets to enforce it. In a Turing-complete context, the execution can quickly become trickier and harder. 

To competently write a normal contract takes years of study and a challenging bar exam. Smart contracts require the same level of skills, combined with technical competence. Newbies should keep themselves away from jobs related to smart contracts.

The link between the digital and the physical version: the Oracle problem

Aren’t smart contracts much more straightforward than typical contracts? In our previous example, Tricia can prove she owns the apartment, and Peter can send money for renting it. No questions of ownership, a trustless relationship, fast execution, no bureaucrats involved. It sounds amazing. Almost too good to be true. 

Smart contracts

In a decentralised context, smart contracts only work if there’s some link between the digital and the physical version. Tricia can sell her apartment to Glenn and, even if Glenn agrees to rent the apartment to Peter, the digital world needs to know about the physical world. Oversimplified, this is known as the Oracle problem.

When Tricia sells her apartment to Glenn, the smart contracts needs to be informed about the transfer. Apart from any compliance-related implications, the apartment can be represented by a non-fungible Ethereum token. For the ease of reading, let’s call this token ‘AOW’ (which should stand for ‘Apartment OWnership’). In this case, Tricia can transfer the apartment’s ownership in a so-called “atomic swap”: she receives a certain amount of ETH, she transfers the AOW to Glenn. That is where the problem lies: Glenn needs to trust that the AOW actually represents the apartment. Therefore, some Oracle must ensure that the transfer of the AOW to him really means that the flat is his, legally.

Further, even if the relevant government authorities say that the AOW represents the apartment, what happens if the token is stolen? Does the apartment now belong to the thief? And what if the AOW is lost? Is no-one in the legal ownership of the apartment? Can the AOW be re-issued? If so, who can re-issue it?

In short, physical assets (Tricia’s apartment, a car, a portion of land) are regulated by the jurisdiction their owner happens to be in. So, it can be said that they trust something in addition to the smart contract someone’s created. The possession in a smart contract doesn’t necessarily mean the ownership in the real world (and vice versa). 

Agreement

The scenario above is a typical example of a smart contract that needs to trust a third party. Trustlessness isn’t one of its features. Because, when the parties trust an Oracle, the latter is a version of a judge. 

Some Real-Life Applications of Smart Contracts

Don’t get me wrong: I believe that the entire Blockchain movement will be able to manage the issues I described above. Further, there are several use-cases of smart contracts that prove the potentiality of these instruments. Let’s take a look at some of them.

Transparency in supply chain

Tracking packages around the world is an arduous task. Smart contracts can simplify it. 

From the moment an item leaves the factory to when it arrives on a store shelf, smart contracts can make the entire process transparent. Let’s think about the case of a contaminated shipment: in this scenario, management would be able to see exactly where each product came from, and isolate the contaminated goods. This helps organisations save costs and keeps buyers safer. 

Medical research

Smart contracts can facilitate sharing data amongst researchers while safeguarding the privacy and data security of the patients and subjects involved in medical research. The most straightforward example is, if the research institution A agrees to pay X to the research institution B for certain data, as soon as the amount due is paid release relevant information from B to A.

Digital Identity

It could be interesting to read a list of all the institutions that hold different details about someone’s life. What if all these pieces of information are collected in one place, by smart contracts. They could make each person’s identity holistic. And his privacy wouldn’t be affected: the individual is the one who decides which information to disclose with whom.

Smart contracts digital ID

Tax payments

Let’s think about the opportunities given by smart contracts used to trigger tax payments automatically: it’s quite hard to find someone happy to pay taxes, but automatic payments would save the taxpayer from fines and prevent him from committing a crime unintentionally. 

Further, if all the data about taxes is recorded on the Blockchain, this transparency would make cheating almost impossible. 

Authorship and Intellectual Property (IP) rights

Piracy and other IP violations are a big issue which affects musicians, photographers, writers. A transparent Blockchain-based registry of authorship is an (ambitious) example of how smart contracts might reduce the number of violations of IP rights. What if the payment of a royalty on an e-book is triggered by a smart contract as soon as the e-book is downloaded? 

Further, artists can choose to sell their work, not in its entirety, but in snippets (this practice is called “micro-metering”, and is used, for example, by video content creators). This is possible only if IP rights are properly managed, and pricing is in control of the artists themselves. 

Incentives for marketing purposes

I’ve been told that one of the most critical processes in influencer marketing is content review. By using smart contracts, marketers can put bounties on content reviews and make instant micro-payments to the reviewers who get the job done. 

In conclusion

Smart contracts open many possibilities for new businesses. The complete list of their applications can’t be foreseen at the moment: while it’s still quite new, the Blockchain technology is developing at a breakneck pace. That’s why many companies, all around the world, are working on them: from startups to large and established enterprises. 

When it comes to smart contracts related to physical assets (which is probably one of the most exciting applications of smart contracts), some further steps must be done by governments and lawmakers to regulate them. But we only need to secure the beginning of the chain to the real world and understand if and how people will react without interaction with the physical world and verifying things before they sign off.

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