Smart contracts could make business deals more efficient and cheaper. However, there are still downsides with this nascent blockchain technology
Should you believe the hype when it comes to blockchain? Over the past few years, people have pledged to use blockchain to fundamentally transform everything from healthcare to democracy. There are even innovators who claim they use the technology to prevent sexual assault and improve childcare. While some of these cases may seem more farfetched than others, it’s clear the business buzz around blockchain may be justified. For one thing, the technology is already used in smart contracts, which make transactions and deals smoother. “The technology is exciting because the possibilities and utility of smart contracts are endless and can revolutionise the way SMEs operate,” says Emmanuel Marchal, managing director at ConsenSys, the blockchain company.
It’s fair to say anything that can evolve the running of an SME sounds ideal. But what exactly is a smart contract? “The simplest real-world conceptualisation of a smart contract is a vending machine – money goes in, drink comes out and no human is involved,” explains Andy Bryant, COO at bitFlyer Europe, the bitcoin marketplace. Obviously, there’s a bit more to it but the core concept is accurate with smart contracts automating deals from the signing of the contract to its implementation. Essentially, once agreed, the contract will trigger every action encoded in it, from payment to shipping, with the blockchain technology theoretically removing the need for solicitors or even trust between the two parties. “In other words, smart contracts provide the necessary levels of trust to transact in an online world,” continues Bryant.
Smart contracts achieve this by using blockchain, a decentralised and autonomous digital ledger where every transaction must be compliant with the previous block of data to be accepted, creating a new block in the chain. “Basically, it’s a computer program intended to digitally facilitate, verify or enforce the performance of a legal contract,” explains Julian Zegelman, founder of TMT Blockchain Fund, the VC firm. “Smart contracts are self-executing meaning they allow the performance of contractual transactions without third party involvement.”
Let’s say two parties agree on a deal, what should be in it and what the different parties should do to fulfil their part of the transaction. Once they sign the contract, the deal will run through a blockchain platform like Ethereum. This means that half of the computers – or nodes – in the decentralised network must agree that the deal is sound before it goes through. This procedure results in there being no other party involved in the process, no centralised authority, other than the two parties making the deal. Moreover, this automation means that, once triggered, no parties can back out of the deal.
As you can imagine, there are several benefits to this concept. “One of the biggest advantages for small businesses using smart contracts is they’re able to trust unknown transaction counter-parties over long distances or different legal jurisdictions,” says Bryant. Moreover, they encourage efficiency. “The use of blockchain allows the processes to be automated which in turn saves a huge amount of time, whilst also eliminating the need for third party involvement,” explains Bryant. “They allow businesses to essentially streamline various complicated processes into one, automated process.
Additionally, the contract theoretically removes the need for judges and lawyers to argue about the grey areas of the contract. “The charm of the smart contract is the promise to eliminate these intermediaries and that the only point of reference will be the code of the contract itself,” says Maurizio Sironi, associate partner at Blockchain Reply, the blockchain advisory organisation. “For this to work, the conditions of the smart contract need to be unambiguous. The boundaries of reasonability would have to be exactly defined, leading to greater transparency and accountability for both parties.”
And that’s where you may encounter a few snags when it comes to using smart contracts. While two people for instance agreeing an item is worth X amount of money is a reasonably straightforward transaction, the problem arises with more complicated deals. “Due to the complexities of computer coding, it’s not yet possible to accurately use smart contracts in all scenarios – many ideas for where smart contracts could be or ideally would be used aren’t currently possible to implement,” explains Emma Stevens, associate solicitor at Coffin Mew, the law firm. The rule is that the more room there is for interpretation, the harder it will be to use blockchain-based deals. “By their nature, smart contracts are unequivocal due to computer coding trends and the need to be black and white to avoid uncertainty so they can execute instructions,” continues Stevens. “They’re therefore only as good as the data they receive and, as they’re programmed and reliant on human data input, there is always the potential for human error.”
And that’s not the only potential issue with using smart contracts. “While blockchain technology is hailed as being ultra-safe, no digitalised system is 100% protected from cyber attacks,” explains Stevens.
This is best exemplified with the breach of the Decentralized Autonomous Organization, or the DAO, a digital organisation. The DAO allowed users to contribute the cryptocurrency ether to a pool that would be invested in proposed projects based on a vote, which would be proportional to how much ether each person had invested. When the DAO launched its tokens on Ethereum’s blockchain in May 2016 it attracted 14% of all ether created at that point. However, in June someone exploited a flaw in the code. “It essentially allowed for an attacker to keep interrupting a transfer at the moment between sending and receiving funds, tricking the receiver into repeating the same transfer a large number of times and accumulating the ill-gotten gains,” Bryant explains. Even though the stolen money, which had a value of roughly $50m, was later returned to its rightful owners, the breach showcases how there are still vulnerabilities in blockchain and, as a consequence, smart contracts.
Clearly there are risks with using this nascent technology. However, if SMEs tread carefully, there are also huge advantages.