Smart contracts and their challenges


In this article I will outline the technological and legal challenges facing the adoption of smart contracts.

Smart contracts, like traditional contracts, are agreements signed between two or more parties, based on a set of conditions. If either party breaches the agreed terms, the contract is invalidated and the entire agreement is terminated, with consequences.

Smart contracts first appeared in 1994, when computer scientist Nick Szabo wrote an essay entitled “Smart Contracts”.

Instead of relying on complicated paperwork or third-party intermediaries, these transactions are conducted through code that exists on a decentralized blockchain that automatically executes the terms of the agreement.

Smart contracts are fully automated, and this means they do not require third-party oversight.

They are much cheaper than a normal contract. Most importantly, security against fraud or manipulation is built into the smart contract mechanism. Because they exist on the blockchain, there is no person or server to influence. In essence, smart contracts are a computer code that recognises two inputs: the terms of the contract, and whether or not they have been fulfilled.

What can be their practical uses?

Uses are as broad throughout the economy as traditional contracts. Application in supply chain management, real estate, automotion, healthcare and other sectors.

For example, a company that wants to raise money for the construction of a building can create a smart contract using the crowdfunding model. In this case, the smart contract would be carried out involving only the investors and the entrepreneur. If the target is reached within the set time, the funds will be automatically released for use, otherwise the investors will receive their funds back.

Not only in the private economy, but also governments will be able to use them to deliver their services faster and more efficiently. Citizens will be able to receive services and fulfil their obligations much faster and without bureaucracy, with the automation of events.

The challenges

Here are some of the challenges facing the adoption of smart contracts.

How can they be drafted and designed?

A key challenge in the widespread adoption of smart contracts is that parties will have to rely on a trusted technical expert to capture the agreement in code, or confirm that code written by a third party is accurate.

There are typical, widely applicable agreements for which it will be possible to design standard templates, to which it will only remain to incorporate particular data from the contracting parties, such as dates, actors, cryptocurrency addresses for payment and collection, etc.

The use of smart contracts will not be without lawyers. While for simple and short agreements it may not be necessary, for more complex ones a lawyer will be the professional advising on legal knowledge.

The need for oracles

Many use cases proposed by smart contracts assume that the smart contract will receive information or parameters from resources that are not on the blockchain itself, which will be provided by oracles.

For example, suppose an agricultural insurance smart contract is programmed to transfer value for risk coverage to an insured, if certain weather conditions exist in the crop area. The smart contract will have to receive the data from an agreed source in the smart contract, i.e. from an oracle running on the blockchain that implemented the contract.

Risk of attacks and bugs

Smart contracts introduce a risk, the possibility that the contract will be hacked or that the code simply contains an unintended programming error.

Given the relative security of blockchain, these concepts are closely aligned; that is, most of the “hacks” associated with blockchain technology are actually exploits of a coding error.

As with many bugs in computer code, these bugs are obvious once they have been exploited.

For example, in 2017 an attacker was able to drain several multi-signature wallets offered by Parity of $31 million in Ether. Multisignature wallets add a layer of security because they require more than one private key to access the wallet. However, in the Parity attack, the attacker was able to exploit a flaw in Parity’s code by resetting the smart contract and becoming the sole owner of the multi-signature wallets.

Applicable law

Global adoption means that parties can develop a smart contract in different jurisdictions, even simultaneously in several of them. What is legal in one may not be legal in another.

Current legal frameworks do not recognise electronic contracts as a legal institution. However, there are precedents that consider the electronic validity of a certain part of traditional contracts, which will facilitate future regulatory change so that smart contracts have their own legality.

Therefore, the challenge for the widespread adoption of smart contracts may have more to do with the jurisdictional limits of the law than with their legality as an instrument.

Concluding words

The challenge facing the DeFi industry in the smart contract segment is certainly not an easy one.

New professions related to the drafting and auditing of smart contracts will emerge.

Some industries and professional associations will oppose their becoming legal alternatives, but I believe that when a technological innovation’s time has come, its development is a matter of time.