Smart contracts are great. They allow us to change from a probabilistic world to a deterministic one. In the status-quo, contracts function in a probabilistic manner, in that there is a probability that the contract will not be fulfilled. This could be due to one entity not fulfilling its end of the contract for example. Smart contracts enable the same type of contract as a regular one, but in a digital format and allows it to function in a deterministic manner. What this means is that once the contract receives confirmation to execute, it will do so automatically and autonomously. This fundamentally changes how contracts, and ultimately the world economy will function in the long run.
Being able to enter into a contract with another entity with a guarantee that the contract will be fulfilled, changes the way we can interact with others. Millions of people in the world live in countries where private property rights are poorly handled, and smart contracts can help them secure ownership rights over their property for example. Instead of being taken advantage of, entities entering a contract know exactly what they are getting into, and they know that the contract will be fulfilled no matter what. This enables existing markets with low trust like the derivatives market to be able to function in a more efficient manner, and opens the doors for brand new markets to emerge as well.
“Smart contracts are estimated to decrease individual loan costs by 480–960 USD and generate savings of 3–11B USD in the US and Europe combined. If we had had smart contracts back in 2008, the increased access to information could have mitigated the debt crisis.”
However, there is a problem holding smart contracts from being adopted. The main problem with this new innovation getting adopted is its lack of reliable inputs and outputs. Essentially, blockchain is a glorified public database. The only value it provides is being immutable which makes it a good option for creating a binding contract between two or more parties that cannot be changed and can execute automatically based on certain external events occurring. Those external events are fed into the contract via an oracle, which is currently centralized and is a single point of failure making the whole thing pointless. This problem is commonly referred to as the “Oracle Problem”. Projects like Chainlink are currently working on a solution to that problem in the form of a decentralized oracle network to feed reliable tamper-proof inputs and outputs for complex smart contracts on any blockchain. For a more in-depth analysis of this project and its implications, refer to my other article “Chainlink: A Fundamental Analysis”.
Smart contracts will also have a much bigger impact on our lives than a peer to peer payment system or a digital store of value. This is because smart contracts eliminate trust. Trust is the factor of the contract that allows it to execute to give the funds to the proper entity. What is the point of the funds on either part of the contract if it fails to execute due to trust?
Despite all the great things that smart contracts can usher in, the question that always arises is if these contracts can execute themselves, wouldn’t that lead to job loss in certain industries? This is correct, but overall the job market would have a net gain due to new jobs that are created. Just like the printing press made all the manual writers of books obsolete, it also paved way to brand new jobs such as editors and designers for example. We will see the same case with smart contracts.
What are the implications of this technology right now?
An easy way to understand how and who this will help in the short-term is to think about how it works now if someone buys a credit default swap: right now their options are to buy the swap knowing that the writer will do everything legal under the sun to delay payment in the event of a payout in order to secure a position first.
This can be seen in the movie The Big Short for example where, during the 2008 Financial Crisis, many OTC dealers delayed payments to clients who shorted the housing market in order to establish similar positions to cover these liabilities. Delayed settlement can reduce payouts due to changes in underlying values between the agreed upon settlement and actual settlement date.
From the perspective of the purchaser, losing even a month or two on that payment could end in their business becoming insolvent. Right now, the only options are to buy the swap and take the chance or go naked since there are no entities that you can trust, no matter how many lawyers you hire.
The first users of smart contracts will be entities with large value transactions in low trust environments. The first people to use phones were the ones who could afford $20 a minute because they made more money off that communication advantage than it cost them. Smart contracts are just like any other technology: it takes something expensive and makes it a lot cheaper. Every other tech follows this path: the people already paying huge amounts for that thing buy up all the early uses and then things trickle down.
The key points here are:
- Trust is an asset of a transaction which costs resources.
- Just as other technologies have decreased the cost of food, electricity, and entertainment, smart contracts will decrease the cost of trust.
- There will still be varying levels of trust needed and varying cost tiers for those levels of trust.
Overall, one can see the various implications smart contracts will have in the real world. Smart contracts offer a superior way of transacting with others in contracts, and widespread adoption will occur sooner than most expect.
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