Smart Contracts: Neither Smart, Nor Contracts?

Unraveling the Myth

Touted as the main factor behind Ethereum’s rise, “smart contract” is definitely up there in the rankings of most-used-crypto-lingo. These two magic words are being thrown all around by the cool kids as a way to illustrate how blockchain technology can magically revolutionize the world. But let’s take a break for one sec, and investigate whether this denomination is deserved…

Let’s start with the first claim: smart contracts are not smart. Despite the name, smart contracts are not capable of autonomous decision-making, self-awareness, instinctive creativity… or any traits you can think of to describe how a human brain works. In fact, a smart contract is just a piece of code that is programmed to execute predefined actions when certain conditions are met. No intelligence involved here, just a set of predetermined rules!

Technical concept

Then why are they called smart contracts? Well, the term was coined by Nick Szabo, a computer scientist, back in 1994 – so rather long before the advent of Bitcoin and blockchain technology. He described the concept of a digital protocol that would facilitate, verify, and enforce the negotiation or performance of a contract. The whole process was based on the idea of a distributed ledger, which would record the terms of an agreement and automatically execute the obligations of the parties involved. Szabo was a true precursor; as we fast forward to today, blockchain technology has made his vision a reality, and smart contracts notably allowed the emergence of decentralized finance (DeFi) in the past few years – as of February 2023, there is about $50 billion in total value locked (TVL) on DeFi platforms globally (you can check these numbers on publicly available website like this one). Beyond DeFi, smart contracts and blockchain technology will certainly revolutionize other industries, from insurance to real estate or supply chain management, as they offer many benefits such as increased efficiency, transparency, and security.

Legal aspect

But let’s keep our focus on our denomination investigation and move on to the second claim now: smart contracts are not… contracts! Well, at least not in the traditional sense. A traditional contract is a legally binding agreement between two or more parties that sets out the terms and conditions of their relationship. It is enforceable by law, and it requires the parties to fulfill certain obligations. Smart contracts, on the other hand, are not necessarily legally binding. Technically they can be programmed to execute and enforce agreements, but in most jurisdictions they are not recognized as contracts under the law. This means that, in the event of a dispute, a court may not enforce the terms of a smart contract in the same way as it would enforce a traditional contract. The consideration is of importance, because smart contracts can be vulnerable to design errors, programming bugs or malicious attacks. If there is a flaw in the code, or if someone gains unauthorized access to the network, the smart contract could be compromised. This could lead to unintended consequences, such as the execution of incorrect actions which typically and more dramatically could cause a loss of funds.

The DAO Attack

One of the most notorious examples of a smart contract-related exploit is “The DAO Attack” from 2016, a significant event in Ethereum’s history. We have written a whole article about it but in a nutshell, hackers exploited a bug in a smart contract that was governing the funds of this decentralized autonomous organization, allowing them to repeatedly request and receive refunds of their investments… It ultimately resulted in the hacker siphoning off approximately one third of the funds (equivalent to around $50 million at the time). Interesting fact: the Ethereum blockchain was eventually “rollbacked” to restore the stolen funds, but not all parties agreed with this decision… It resulted in the network splitting into two distinct blockchains: Ethereum (ETH) and Ethereum Classic (ETC). It was a wake-up call for the Ethereum community and highlighted the importance of auditing smart contracts to prevent vulnerabilities.

Benefits & Limitations

So, are smart contracts a worthless technology? Absolutely not. While they may be neither smart nor contracts in the traditional sense, they offer many benefits that cannot be ignored. By leveraging blockchain technology, smart contracts can automate the execution and enforcement of agreements in a transparent and decentralized manner. They can reduce the need for intermediaries, lower costs, and increase the speed and efficiency of transactions.

However, it is important to recognize the limitations of smart contracts and to use them in a responsible and careful manner. Smart contracts should be designed and implemented by experts who have a deep understanding of the technology and the legal implications of their use. They should be used in conjunction with traditional contracts and legal frameworks to ensure that the parties involved are protected and their rights are respected.

And hey, who knows? With the advances of artificial intelligence, and the popularization of smart contracts’ usage which could lead to legal recognition in the world’s main jurisdictions, maybe the situation will evolve… AI on the blockchain recognized by the law, now that would be some really-smart legit-contracts!