Smart contracts, key to broader adoption of blockchain, face their own hurdles
Summary:
A key driver accelerating adoption of blockchain technology has been the promise of smart contracts, codes deployed on blockchains1 that enable them to run programmable applications. Smart contracts are called “smart” because they are self-executing – they run when certain conditions are met – and are intended to eliminate most costs associated with writing and executing contracts. They can decrease counterparty risk, boost productivity, cut expenses, embed compliance rules and controls, and add levels of transparency to multiparty digital agreements. Although smart contracts are not yet a substitute for traditional, legally binding agreements, smart contract developers aim to make many different types of contracts self-executing and self-enforcing. To gain acceptance, smart contracts will need improved cybersecurity and legal frameworks that ensure their enforceability.
Smart contracts have greatly expanded real-world applications of blockchain
technology. Although some blockchains have thrived without smart contracts – Bitcoin, for example – most new blockchains are designed to enable structured programmable applications. Smart contracts are now used in Decentralized Finance (DeFi)2 to allow market participants to trade, lend and borrow assets without an intermediary. Smart contracts are a powerful tool for automation, because they are not controlled by any central administrator. Lack of technological standards for smart contracts creates vulnerabilities for blockchains. Smart contracts' code can create additional points of vulnerability to cyberattacks for blockchains. Increasing reliability and security of smart contracts by introducing industry standards is key to advancing blockchain development.
Regulatory authorities are actively examining smart contracts. The elements of a traditional legal contract that make it enforceable, such as an offer, acceptance and consideration, have been particularly difficult to unbundle in smart contracts. In addition, smart contracts' automatic execution and immutability makes it hard to resolve disputes.
Some governments and regulatory bodies are adapting existing legal frameworks to financial transactions involving digital assets and smart contracts by incorporating new concepts unique to decentralized finance.
If widely accepted, smart contracts could enable noteworthy shifts in the financial sector. If industrywide technology standards that make smart contracts secure are developed, and if legal frameworks are in place ensuring smart contracts' enforceability, the financial sector may also have to change to accommodate a much more automated way of doing business.