The flurry of blockchain applications and use cases that have burst into the marketplace during 2020 and 2021, from decentralized finance (DeFi), decentralized exchanges (DEXs), and non-fungible tokens (NFTs) have captured the attention and investment dollars of the marketplace.
Under the radar, however, a different blockchain application continues to garner relatively little attention, but is playing a critically important role enabling many of these higher profile applications; smart contracts. Underlying this entire idea is the reality that blockchains, in and of themselves, are records of transactions and other data that have previously occurred. These records and information contained therein are (depending on who is asked) immutable and/or extremely difficult to hack or otherwise breach, but are still just records of previous transactions.
The real question then becomes, how can this information and these blockchains successfully interact with other technology systems, and how can the data contained therein have its utility maximized? Specific answers will inevitably vary, especially for permissioned, enterprise, or hybrid blockchains, but a commonly used interface is a smart contract. There may still be some confusion as to what exactly a smart contract is, or some negative connotations linked to smart contracts (like the infamous DAO hack), but these are important tools to understand.
Let’s get into it.
Not contracts. Although the name would indicate otherwise, smart contracts are neither technically smart, nor are they identical to contracts. What a smart contract represents is programmable and executable code that is embedded, or a part of, an underlying blockchain. The end result may be the same, but instead of contractual clauses and written words, coding language and executable clauses drive the process forward.
Logic is key. While it is true that smart contracts are not smart, that does not mean there is nothing of interest occurring in these applications; quite the contrary. A smart contract, in essence, represents an attempt by coders and programmers to code and create certain business logic in a virtual environment. This business logic can be something as simple as payment automation and inventory confirmations, or as complex as managing and executing how certain stablecoins are stabilized.
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Enforceability ambiguity. Something that might seem like old news to those more familiar with the blockchain and cryptoasset sectors, legal authorization, enforceability, and other jurisdictional issues remain somewhat ambiguous. This may be better known in term of the accounting and financial reporting inconsistencies that exist, but this exact same issue exists for smart contracts. Legal enforceability and differentiation are complicated transactions at the best of times, and adding in coding language on top of legal agreements is only amplifying these facts.
Control evolution. In an ideal situation, the greater integration of automation and digitization into executory agreements would make these agreements more secure, and less susceptible to fraud. That is true, to an extent. What is also true, however, is that in order for smart contracts to operate as advertised there need to be controls around the smart contract itself. Namely, organizations need to assess 1) who has access to the programming language that creates the smart contract, 2) how this control is updated or modified over time, and 3) how these controls take into account changing business conditions.
Flexibility. One last point that organizations should be aware of is that, just like in business at large, there are numerous times where business conditions change; smart contracts must have the ability to respond to changing conditions. This might take the form of more nuanced programming at the onset, or take the form of allowing employees to manually modify and change the contract itself. In either case, adding this extra complication can increase the cost and control considerations related to smart contract implementation.
Smart contracts play an important role for both blockchain technology, as well as managing the fast-growing and differentiating cryptoasset sector. These applications have the ability to automate, streamline, and otherwise maximize the potential of blockchain technology especially as it pertains to enterprise utilization. With every rapid advancement there will always be complications for organization to take into account, and this is equally as true for smart contracts as other tools. That said, blockchain and crypto applications increasingly rely on tangential programs to operate effectively, and smart contracts look like they are here to stay, and will have an important role to play going forward.