'Smart Contracts' Are the Future of Blockchain

As far as digital currency has come, the passing of bitcoin for purchases is still a relatively primitive transaction. But what if you could program such transactions to occur at preordained times, under set circumstances, and even involving a preregistered group of multiple counterparties? Scanning your groceries triggers paying the grocer. A football score automatically leads to movement of funds between anyone who bet on the game.

And what if you could use similar technology to preprogram transactions such as the payout of a derivative or other security, all done through a public ledger system such as blockchain without the risk of intervention or the inefficiency created by the involvement of an intermediary counterparty agent?

To a certain extent, that day is already here through the development of "smart contracts" — a concept that predated bitcoin itself. The term — first coined by one of bitcoin's alleged creators, Nick Szabo, in 1993 — essentially means "programmable money" or self-automated computer programs that can carry out the terms of any contract. The finer points of what programmable money is are still being worked out by enthusiasts, but most agree that it is a financial security held in escrow by a network that is routed to recipients based on future events, and computer code.

The original technology around smart contracts was mostly a thought exercise that sat dormant for over a decade until programmers could find a useful medium in which smart contracts could exist. That medium was finally available through the world's first blockchain in 2009. Unknown to most people, all bitcoin transactions are smart contracts. Many institutions, which are increasingly exploring the use of blockchains for value settlement, have been similarly dabbling in the application and uses of smart-contract technology.

But the potential benefit of smart contracts has only scratched the surface. The nature of bitcoin's design is such that most of these transactions are limited to the mere passing of bitcoin itself, without much consideration to the world outside of the bitcoin network. The principal feature that bitcoin lacks, and which is needed by most financial institutions, is called "Turing completeness." Named for the famed mathematician Alan Turing, such completeness allows computer language to carry out a wider array of more precise instructions — to simulate all conditions in the natural world.

A growing number of public blockchains have explored ways to harness smart contracts for greater uses. The principal feature of smart contracts is the risk reduction available through nondiscriminatory execution, which for some, will lead to greater economic benefits. Put another way, it's a smart contract's lack of a central counterparty agent that will enable these contracts to service markets with greater efficiency. And much like bitcoin itself, smart-contract technology can unlock untapped markets by circumventing existing regulatory infrastructures. This could lower the costs for a subset of our most common financial transactions.

So why did the original bitcoin network stop short of enabling Turing completeness? It was omitted from bitcoin not because of limitations in the understanding of computer science concerns but instead due to the economic incentives that such power would create. Supporting such a powerful ability for programs to execute transactions exposes the blockchain to the risks of economic forces, which may compromise the blockchain's security. Enabling a blockchain to process the economic value of high-value assets increases the profit that could be captured by bad actors who would seek to disrupt market activity by disrupting the blockchain's performance. However, competitors to bitcoin haven't been nearly as bashful when offering competing designs.

Chief among these competitors is the so-called "private blockchain" industry, which has been quick to provide the robust smart-contract options that bitcoin lacks. However, these companies have only been able to offer such solutions by removing the ability to settle amongst untrusted parties, and instead, relying on security through trust. It is questionable whether much more efficiency remains in such a private ledger model.

In the public blockchain space, only the Ethereum project has undertaken any plans to offer a robust smart-contract platform with Turing completeness. But the success of this blockchain has been commensurately underperforming bitcoin's security standards by many orders of magnitude. In no small part, this is due to the onerous economic burden that its smart-contract implementation places onto its miners.

Other small steps in expanding smart contract options through the public blockchain space have come through announcements by firms such as t0 and Symbiont that their companies will begin offering public "smart securities" on their networks. Similarly, stable fiat currency assets are being offered by companies such as Tether and Bitt, which will enable the use of more reliable stores of value on the bitcoin blockchain. Though the smart-contract features that are available in the bitcoin space are minimal, having assets available for public manipulation is a needed step in the direction of more widespread adoption.

Much like the other projects in the blockchain and distributed ledger space, it would be expected that private blockchains will remain a staging ground for corporations to prototype their contracts as public networks reach maturity. However, as firms quickly realize that far more robust financial platforms for algorithmic processing already exist in trusted environments, smart contracts on these platforms will likely be relegated to that of mere curiosities as the medium of trustless public settlement fully develops.

Chris DeRose is the community director of the Counterparty Foundation.