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Virtual Ventures

May 2016

Smart contract is a self-executing computer protocol that executes the terms of a contract. But does it really reduce financial transaction costs?

One of the biggest benefits attributed to the developments of the Internet is the ease in trade. Be it at the institutional or the retail level, it has enabled deals across denominations and geographical boundaries. Amidst all of this, there remains the ethereal element of trust. This has seen the emergence of platforms including eBay, Amazon, Alibaba, amongst others which don the role of the middleman, in exchange for a fee and setting limits and controls on the way business is done, deciphered by their understanding of trust. Can this P2P trade be done otherwise with just the involvement of the parties, the buyer and the seller? Smart contracts may well be the answer to the same.

Pioneered by Nick Szabo as early as 1997, recent advancements in the field of Blockchain technology have invigorated interest around Smart Contracts. He defines a smart contract ‘as a computerized transaction protocol that executes the terms of a contract. The general objectives of smart contract design are to satisfy common contractual conditions (such as payment terms, liens, confidentiality, and even enforcement), minimize exceptions both malicious and accidental, and minimize the need for trusted intermediaries. Related economic goals include lowering fraud loss, arbitration and enforcement costs, and other transaction costs.’*

He extends the example of the vending machine, describing it as the ‘primitive ancestor’ of a smart contract. Within a limited amount of potential loss, the machine takes in coins, and via a simple mechanism dispense change and product according to the displayed price. The vending machine is a contract with bearer: anybody with coins can participate in an exchange with the vendor. The lockbox and other security mechanisms protect the stored coins and contents from attackers, sufficiently to allow profitable deployment of vending machines in a wide variety of areas.

With the software automating nearly all of the contracting process, dependency on human element could be done away with, thus greatly reducing the need for litigation arising out of disputes. Parties commit themselves to be bound by the rules and the ultimate ruling as determined by the code – this on a lighter note, has raised fears amongst the legal society on Smart Contracts jeopardizing their future. Other benefits include the overall speeding up the entire process besides, lowering costs and less likelihood of errors.

The concept though has long suffered from the lack of support in terms of technological infrastructure. However, the advent of cryptographic protocols, cryptocurrencies and blockchain are driving expectations around the adoption of Smart Contracts in the near future.

Cryptographic Protocols: A cryptographic protocol is designed to allow secure communication under a given set of circumstances. It ensures the communication bears secrecy, requires authentication, ensures fairness and non-repudiation.

Blockchain: A blockchain is an computer network which provides its users with digital bearer instruments. It defines how energy can be burned, in order to allow each participant on the network to operate the ledger in a secure way without the need for a central authority.

Cryptocurrencies: Cryptocurrencies are based on the idea that a blockchain, can replace the role of a bank as a middleman in financial transactions.

The World Economic Forum (WEF) identified blockchain technology as one of its six mega-trends expected within the transition to a more digital and connected world. It highlights a direct positive impact, ‘Contracts and legal services increasingly tied to code linked to the blockchain, to be used as unbreakable escrow or programmatically designed smart contracts’. From the look of it, Smart contracts are poised for widespread adoption in the coming years – while the industry remains mired amidst ‘hows and whys’, the scope and scale of accruable benefits are bound to transform the way business is done.

Here are inputs from Mr. Chris DeRose, Bitcoin evangelist, public speaker, and Community Director of the Counterparty Foundation

Q. On one hand there’s  a lot of hype around Smart Contracts posing a threat to humans in the legal space. On the other the fields at a very nascent stage. Ripple discontinued the Codius playform and Cryptocurrencies have been popularized by Bitcoin and recently Ethereum. Which side would you veer towards and how do you see the future of Smart Contracts panning out?

A. There is no threat to the legal space arising from smart contracts. Smart contracts only provide an efficiency for the under served. When value is held in collateral (as is the case in all registered assets), that means that legal process supersedes programmatic process, thus rendering any potential efficiencies moot. It is likely that the undeserved will use smart contracts in ways that parallel legal processes, however, if they’re currently undeserved, then they won’t be displacing legal service.

I don’t believe the Codius platform is a smart contract. The prototype architecture wasn’t any different than incumbent models for financial programming. Ethereum I’ve written extensively about, and their problems are numerous, the cost of this platform’s overhead is simply to immense to support any non-trivial amount of commerce. bitcoin’s smart contracts are available today, and used by many, I believe it’s highly probable that bitcoin’s model will succeed.

Q. What are the immediate hurdles this entire segment faces?

A. The amount of science being performed in the space is currently fairly small, and the amount left to do is enormous. This lack of science, coupled with the enormous distractions in the form of hucksters and profiteers promising snake oil makes for a difficult environment going forward. Probably there is too much interest in the space chasing unicorns that can’t exist, and so long as people are trying to get rich quick, it makes it difficult for the humbler practitioners to do real work.

* Source – Wikipedia

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