What are smart contracts?

Smart contract: a digital agreement where you can programmatically code “if this” happens, “then something else happens.”

For example, you could write a smart contract to replace your paper contract for something like a mortgage, loan, employment agreement, smartphone payment installment term, or a terms of service agreement.

Ethereum isn’t the only early-stage smart contract platform in existence right now (e.g. Blockstack is an up-and-coming contender), but for now Ethereum has first-mover advantage and a market capitalization currently second only to Bitcoin, so for this article we’ll focus exclusively on Ethereum and its rapidly emerging ecosystem.

Bitcoin has some very limited scripting capabilities, but the core functionality of Ethereum lies both in its blockchain design and use of its Ethereum Virtual Machine (aka. EVM, and commonly described as a “world computer”).

The EVM operates similarly to Bitcoin in that its decentralized nodes are connected by a peer-to-peer networking protocol. Beyond that, the EVM offers opportunities for much more complex computation than Bitcoin.

Bitcoin is a protocol designed specifically for payments, whereas the EVM is “Turing-complete” (meaning any computation run on one EVM node is able to be run on another node), and any smart contract instruction set runs on each one of these nodes. Similar to functions, smart contracts can call other smart contracts, creating a complex ecosystem.

The ether token, through the use of “gas”, is designed to be the fuel that pays for the execution of these smart contracts.

The EVM allows for the development of decentralized applications (dapps), therefore greatly extending the usefulness of blockchain technology.

The Ethereum Foundation documentation refers to this dapp platform as “Web 3.0”, a backend for a new kind of decentralized and secure internet.

Pros and Cons of Smart Contracts

As with any major new technological innovation, it is difficult to foresee exactly what the most popular use cases will be, and also how unexpected bugs affect the system.

Pros:

• Decentralized: removal of single points of failure with workflows such as VPNs (dramatic privacy improvements vs.centralized VPNs), distributed computation (imagine an Amazon Web Services-like platform that pays you for free CPU cycles on your computer), and distributed storage (imagine a Dropbox-like platform where you get paid to host small, encrypted shards of someone else’s data)
• Inclusive: Anyone can write a smart contract, it’s not just for big companies, or the coding elite
• Intermediary-free: Smart contracts replace expensive intermediaries from contract negotiation and execution
• Income: Many smart contracts are pay-to-use, with you as a prospective service provider receiving the platform’s token as payment

Cons:

• Hacking: Smart contracts have a large attack surface, evidenced by major hacks as was the case with The DAO Hack and multiple Parity wallet multisig hacks
• Irreversibility: Major hacks destabilize the ecosystem both technically and economically because value transfer between smart contracts is generally irreversible
• Unintended consequences: Smart contracts are a very permanent form of agreement and current technology does not include essential elements of a mature legal system, such as appeals, arbitration, and mediation

The smart contract space is just now beginning to set a rubric for security best-practices, ICO critiques, and many other key guidelines necessary to producing a healthy ecosystem.

Current Examples of Smart Contracts

Ethereum Name Service

Have you ever seen an ether address? A checksummed address looks like this:

0x7cB57B5A97eAbe94205C07890BE4c1aD31E486A8

For most people this is very difficult to read, and blockchain addresses in general tend to look similar. The ENS fixes all this through its smart contract, which is also interacted with via an ether address. The goal of the ENS is to radically improve the internet’s current domain name system with addresses that appear similar to email, such as “onemonth.eth”.

Initial Coin Offerings

ICOs allow startups to raise massive amounts of capital in incredibly short time periods compared to the traditional venture capital method. Even companies without working prototypes have raised millions in the span of days, without any vetting from educated investors. ICOs have their own pros and cons which are worthy of a separate article.

There are a few promising projects, and a massive amount of scams. ICOs have dramatically impacted the tech industry in just this past year. Startups and venture capitalists are working as fast as they can to leverage this new method of fundraising.

Ethereum’s 2014 pre-sale is commonly considered the first ICO. Most ICOs create ERC-20 tokens, a standard that enables token transfer on Ethereum’s blockchain.

Decentralized Exchanges

For most people it is convenient to purchase tokens on user-friendly exchanges such as Coinbase, Bittrex, Bitfinex, and many others. One of the core value propositions of blockchain technology however, is that it is decentralized, and centralized exchanges are a point of vulnerability, as was brutally demonstrated by the 2014 Mt. Gox hack.

Centralized exchanges are also running into issues with regulatory bodies like the SEC all over the world and due to legal concerns do not always list in-demand ICO tokens when they become available for trading. China, for the moment, has banned both token exchanges and ICOs entirely. There is much ongoing debate regarding how regulators should treat blockchain-based assets and the exchanges on which they are traded.

Enter the decentralized exchange: an automated exchange that serves any jurisdiction. There are a couple to pick from currently, and more on the way every day:

• Etherdelta
• Radar
• The 0cean (upcoming)
• Kyber (upcoming)

Conclusion

Smart contracts are an innovation that are here to stay. However, the technology is immature and needs better scaling and security. Much learning is required to get up to speed on what happened, what’s currently happening, and what trends to expect. We’re here to help you grasp what this brave new world means for you, and for society in general.