Smart contracts, what they are and they are not

Monday, 25 february 2019 | Redacción CEU

The emergence of Blockchain technology has not left the financial world indifferent. Although some of its first applications were cryptocurrencies, Blockchain has not ended there. There is a wide range of proposals and innovative solutions based on this technology. Smart contracts are a good example of that. Although the term has become fashionable, and lately is in the spotlight on the debate about Blockchain, there are still many doubts that have arisen in relation to this concept. Today, at The CEU IAM Business School, we try to shed some light on what exactly "smart contracts" are. Are these contracts really smart? Are they properly treated as contracts? What limits do they find in their operation? What will the future of this technology be like?

Although in 1995 the infrastructure which was necessary to start them up did not exist, Nick Szabo already managed to define what smart contracts were at the time:

<<A set of promises, including protocols within which the parties perform on the other promises. The protocols are usually implemented with programs on a computer network, or in other forms of digital electronics, thus these contracts are "smarter" than their paper-based ancestors. No use of artificial intelligence is implied>>

His theory, at that time impossible, would become a reality fourteen years later thanks to the arrival of Blockchain. To understand the operation of these contracts, it is essential to know what the specific characteristics of Blockchain are: decentralization, immutability, its ability to put value at the core,... We recommend that those interested read any of the Blockchain articles which were published on the CEU IAM blog: What are the applications of Blockchain? and Why can  Blockchain transform finances?

A review of smart contracts

Smart contracts have certain special features that make them special. They are capable of executing themselves. Therefore, they do not need the intervention of a third party, and this can be considerably profitable. In addition to being autonomous, they are automatic. This makes them to be faster than any other type of contract, whether they are verbal or written. In a certain way, the terms in the contracts work as orders, which prevents them from being interpreted in a different way. In turn, Blockchain technology gives them a immutable, safe and transparent character.

However, some aspects of this concept should be put into context. It is quite frequent that, in conferences and debates on Blockchain, sayings such as "smart contracts are neither smart nor contracts" comes up. In fact, María Concepción de Monteverde, Blockchain Director at Banco Santander, used a similar sentence in the recent masterclass Blockchain and its application in the financial field at the CEU IAM Business School –this video is available on our Youtube channel–.

This popular expression tries to explain that more than a contract in itself, smart contracts are codes within a distributed database that enable the conditions of a previous contract to be fulfilled. The involved parties have had to reach an agreement before. Another option is that one of the parties is the one that establishes the conditions, and it does not give rise to any type of negotiation. Therefore, when talking about smart contracts, we refer more to the execution of contracts through Blockchain than to something else. Besides, they are not particularly smart as the operation of these "contracts" is based on an automated process.