Sean Bennett, Stronghold Co-founder & CTO
At Stronghold, we are constantly exploring innovative opportunities to expand the application and impact of blockchain. One such opportunity is the evolving relationship between blockchain and smart contracts.
But what are smart contracts anyway?
How do they relate to blockchain?
Can we even use smart contracts?
If so, what for?
Why call them smart contracts?
Let’s start with the name itself: "smart contracts."
The term “smart contracts” is almost a misnomer. It might be misleading to call it a contract, because it puts into people's minds the idea of legal agreements. However, unlike a static legal agreement, smart contracts operate more as software agreements or APIs. Smart contracts provide predefined methods, such as payment authorization and refunds, ensuring certain functionalities are always available. All a smart contract does is execute code in a way everyone expects, with rules encoded and transparent for all to see on the blockchain.
The benefits of auditing
All a smart contract really is just some code that executes something in a way that's expected by everyone. The sort of rules are encoded into the code when it goes to the blockchain. Everyone can audit it.
Blockchain's transparency allows for public auditing of smart contracts. This transparency is important to remember due to the fact that smart contracts must operate within a blockchain environment to maintain their integrity. However, a smart contract doesn’t necessarily need to be on a public blockchain. There are also private blockchains as well as public blockchains, but private blockchains diverge from the open-access nature typically associated with blockchain technology.
No trust necessary
One of the most significant advantages of smart contracts is the elimination of the need for trust. In scenarios involving numerous parties with no inherent trust, this is crucial.
For example, in the public domain, where anonymity is often preferred, smart contracts offer a reliable alternative to traditional legal contracts, ensuring compliance with predefined rules without the need for trust in multiple parties.
Blockchain, smart contracts, & the real world
At this point, I want to note the distinction between native blockchain functionalities and smart contracts. Some blockchains, like Bitcoin, offer limited native functionalities. Others, like Ethereum, with its Ethereum Virtual Machine (EVM), allow users to deploy custom code. This flexibility makes Ethereum a popular choice for developers, as it provides a playground where you can build anything that’s computationally possible.
For years now, we have been protocols that have relatively stable core set of features branching out to build EVM-style smart contract capabilities (such as Stellar’s Soroban) or dedicate efforts to build specific new native functionalities for their customers (such as XRP Ledger’s desire to add native lending to the ledger.) Each of these protocols carry their own unique benefits. The EVM-style smart contract capabilities offer flexibility but are more prone to developer error while native protocols are less flexible but require less custom development and are “safer”.
Parallel to the advancement of smart contract capabilities, industries are beginning to consider the benefits of leveraging blockchain and smart contracts for payments and trade. An example would be cross-border trade. Traditional cross-border trade methods involving banks and financiers can be cumbersome. The process involves too many third parties, currency conversions, and compliance requirements.
Smart contracts streamline this process by ensuring transparent and reliable transactions with less need for intermediaries. The potential problems that follow additional parties, such as banks issuing letters of credit, are simplified, speeding up settlement and enforcing agreement terms, ensuring that you don’t need to trust the other party.
The challenges of smart contracts
There are challenges, obviously.
The most notable challenge is how to create a bridge between the digital and physical worlds. While smart contracts can seamlessly manage digital transactions, incorporating real-world elements today often requires traditional legal contracts. Blockchain technology is advancing quickly and there are ongoing efforts to simplify the translation of legal language into smart contract code, but the complexity involved is not trivial.
As an example of this complexity, let’s consider shipping television sets. Obviously, television sets, being physical assets, cannot be put on a blockchain. Therefore, shipping television sets still requires a traditional legal contract. The current gap between blockchain and real world assets makes it somewhat difficult to envision a future where all transactions are facilitated through smart contracts at scale.
That said, as blockchain technology continues to innovate on more efficient transaction agreement models, I am confident that traditional legal contracts will continue to bridge the gap in the meantime. I also would like to acknowledge the current work being done in the direction of plain English, language-friendly blockchain rather than just a whole lot of code as a pivotal effort with positive momentum towards aligning digital and physical financial models.
I think what people are excited about, though, is AI interacting with smart contracts in ways where we won't have to build all of those interactions out manually. The AI should be able to figure out [...] the universe of smart contracts.
AI & smart contracts
AI offers a lot of possibilities and promises to enhance smart contracts. AI could optimize interactions with smart contracts and assist in their development, reducing human error and increasing efficiency. But, we must tread carefully as the rapid advancement of AI and its integration with smart contracts raise valid concerns about safety and control.
Despite these promises, integrating smart contracts into current mainstream business processes comes with significant risk. Technical issues, such as bugs in the code or the blockchain itself, and the potential for exploitation by hackers, are major concerns. To mitigate these risks, it is essential to have liability clauses to address deficiencies in smart contracts.
We need players with resources to be trying things out, even if it doesn't make commercial sense immediately.
To the future
There is a bright future for smart contracts, but widespread adoption requires caution, care, and focused consideration. Businesses need to understand the possibilities as well as the limitations of smart contracts, focusing on network-level applications rather than individual use. As blockchain evolves, collaboration and experimentation by entities with ample resources in building, improving, and auditing smart contracts will be crucial in unlocking their full potential.
Realizing this potential requires understanding and addressing technical challenges, ensuring transparency, and fostering trust among those involved. The businesses that start learning how to navigate these complexities now will harness the power of smart contracts to drive innovation and efficiency in the future of finance.
We urge businesses to start exploring and experimenting, even if it's just for the sake of learning, to be better prepared for the future.
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