Blockchains in their current form have evolved gradually. In this Chapter we discuss smart contracts, which are commonly put under development phase titled Blockchain 2.0. First, we discuss the development of blockchain before that and as the development is already in the phase of Blockchain 3.0, we take a glance what it means. Second, we introduce the concept of smart contracts and Ethereum which is currently the most used platform for implementing smart contracts. Third we discuss the assets of smart contract and smart contracting, along with its critique and technical limitations. In the end, a video will sum up our discussion with its practical viewpoint.

Blockchain 1.0 is thought to be its first well-known application, namely Bitcoin. The economic crises in 2008 expedited the use of blockchains for currency, both for currency exchange and a new form of investment. Blockchain 1.0 is simply a ledger that records transactions over time and our discussion so far has limited itself to this type of simple ledgers.

Blockchain 2.0 is about smart contracts. The development of blockchains was heavily influenced by the launch of Ethereum in 2015, which boasted with its ability to handle a very large number of online contracts at the same time. The hype went highest in 2016, when Ethereum was hoped to challenge the traditional contracts all together. However, the Ethereum’s smart contract functions were hacked the same year, resulting in considerable economic losses to its users. Ethereum succeeded in making blockchains more mainstream and in introducing their use outside financial concerns, and, despite the hack, Ethereum is still up and running.

Blockchain 3.0 is about decentralised applications. This introductory course does not go to the depth needed to understand Blockchain 3.0’s functions, but it can be used, and is currently being studied to be deployed in education, health and sciences. Blockchain 3.0 is also making positive impact on governance and it can be used in decision-making, possibly as outlined in previous chapter. The main technical breakthrough is that the decentralised applications enable serverless networks and therefore transparency of functionalities provided by the network. These developments rely heavily on previous applications and, in particular, smart contracts.

A key technology for blockchains is so-called smart contract. Smart contract is a software that runs on a blockchain. In practice, it is a user account that can be contacted with messages. These messages, when sent correctly, activate functionalities in that user account that are automated to work whoever gives the commands. This enables organisations and individuals to share some form of data through a user account. Smart contract is therefore not really a real-world contract but rather a code that runs inside a blockchain network. The public code that is inserted into this type of automated user account (i.e. smart contract) enables its users to agree upon transactions done with the help of that code. These transactions can be e.g., payment terms on rents or bets on a casino. They can be also very complicated, contract-type agreements between corporations, or anything in between. The smart contract automatically implements the terms of agreement, when the demands of running the given code are met.

Figure 1.1Smart contract and its activation.

Ethereum is a blockchain network that is specialised in providing its users a platform for smart contracting. Founded in 2015, its new version Ethereum 2 or Eth2, can allegedly (November 2020) process as many as 100,000 transactions per second, while Visa can process 45,000 transactions per second. This means that blockchains and Ethereum in particular are trying to gain the processing speed of large financial institutions. However, they have not yet been successful. There are other blockchains that enable smart contracting as well, but Ethereum is the largest, fastest and most used. The talk was in 2016 that Ethereum will overthrow the traditional lawyers’ work with the smart contracting. This ceased with the collapse of Ethereum against a coordinated hack that forced millions worth of Ether (ETH), a cryptocurrency used by Ethereum, into wrong hands. Even though technically the Ethereum blockchain itself stayed intact, but the Decentralized autonomous organisation (DAO) was hacked with the help of smart contracts, the Ethereum system itself was repaired and modified, and as Ethereum has been solid in its functions for years now, the talk is again gaining momentum. However, in the summer 2021, Poly Network, a transaction software built on Ethereum, just lost a staggering 600 billion dollars’ worth of cryptocurrency tokens. Therefore, the race between cryptocurrency developers and hackers is still ongoing.

The proponents’ main argument for smart contracting is, that as the smart contract can automate the jurisdiction between users of the blockchain, there is no need for law enforcement: all the contracts are agreed upon by the users, otherwise they are not put into action in the first place. This would, or so the argument goes, release lawyers from acting upon a breach of contract into making them for smart contracting. This would incur savings for making contracts, as the law firms would not be needed in making them, but they could just assist making sure all the needed factors are taken into account while producing the code for the smart contracts. Needless to say, this has built a hype around smart contracts, with many prominent CEOs (like Jeff Garzik, CEO of Bloq) advocating its use.

The critique on smart contracts state that they are very different. Low and Mik (2020), in their article “Pause the blockchain legal revolution” base their argument on the fact that smart contracts do not operate in the real world and therefore cannot substitute real world law. There are too many instances where smart contracts can be rigged to suit malicious needs. They point out that even the concept of “blockchain” is not well-defined in the law. Low and Mik proceed by showing that the code in any blockchain is produced in a centralised manner, by code developers. How trustworthy is this centralised code for the needs of law? In the next Chapter, we will touch upon the validation of transactions and its algorithm, which Low and Mik (2020) consider inadequate in terms of law. They continue by pointing out similar flaws in immutability of a blockchain, registries, centralisation and forking chains. These are all real issues, which need to be considered, when blockchains are being developed. On this course, we will discuss them when we understand better what they are.

So, are smart contracts the next big thing? It seems there are good arguments both for and against. Let us consider this via help of an example. Let us say I would like to lend out my bike for a duration of one year, as I am moving abroad. The lending would enable for another person to have the bike for one year and maintain it so that I would not need to worry for its maintenance or safe-keeping and would receive it back after a year. Let us further assume we would make a smart contract on the matter. The bike would be rented on Ethereum cryptocurrency, Ether (ETH) and I would get the bike back after one year. The smart contract would have a certain penalty (say, on ETH) if I would not be happy with the returned bike, and another one if I would not receive it at all.

All fine, seems that the smart contract holds. However, let us assume that the bike gets stolen during the year I am abroad. If this is not accounted for in the smart contract, then me and the lender cannot proceed without the need of a lawyer, or most probably, a real-world settlement of the issue. Another issue altogether is, which countries’ jurisdiction would be applied on ETH based transaction. However, it might be that the lender is very tech-oriented and has a Ethereum insurance on the bike. Then this smart contract would include the case of theft and maybe have some incurred funds (ETH) transferred to lender’s Ethereum account. However, if my smart contract with the lender would still not include the act of theft, then these smart contracts would not communicate the ETH to my Ethereum account. At the same time, if the theft is accounted for in our smart contract on the bike, then automated contracts would proceed without any need of contracts outside Ethereum.

It seems there are no clear-cut answers. On the on hand, smart contracts can alleviate the need of other type of contracts, on the other hand they can just end up making things more complicated. There are ready institutions like country-specific or EU jurisdiction for handling cases like theft, and also smart contracts are under this jurisdiction. However, sometimes it is hard to decide which countries’ jurisdiction is applied. Be that as it may, as the smart contracts are very central to the present functions of any blockchain, they should be understood and studied meticulously before deciding on their usefulness. At least on this course, we will be referring to the often.

Video: Smart Contracts, Simply Explained

Further reading

Further reading

Blockgeeks, Smart Contracts: https://blockgeeks.com/guides/smart-contracts/