When people use apps or services like Netflix, Instagram, Amazon, etc. they sign, or rather virtually accept, digital user agreements. Digital agreements have been around since the 1990s. These agreements are written and enforced by the institutions that create these services and products. However, in certain conditions, these systems fail and these digital or service-level agreements can be breached, causing people to feel robbed.
A recent example of this is the Robinhood scandal that occurred in mid-2021. Essentially, people came together and all wanted to buy the same stock. However, Robinhood ended up restricting buying, citing issues with volatile stock and regulatory agreements. As a result, they ended up paying $70 million dollars in fines for system outages and misleading customers. And individual customers were left feeling robbed. This was partially the result of centralization and Robinhood having full control over the platform as well as enforcing the digital agreement.
Zak Ayesh, a developer advocate at Chainlink recently came to Duke to talk about decentralized Smart Contracts that could solve many of the problems with current centralized digital agreements and traditional paper contracts as well.
What makes smart contracts unique is that they programmatically implement a series of if-then rules without the need for a third-party human interaction. While currently these are primarily being used on blockchains, they were actually created by computer scientist Nick Szabo in 1994. Most smart contracts now run on blockchains because it allows them to remain decentralized and transparent. If unfamiliar with blockchain refer to my previous article here.
Smart contracts are self-executing contracts with the terms of the agreement being directly written into computer code.Zak Ayesh
There are several benefits to decentralized contracts. The first is transparency. Because every action on a blockchain is recorded and publicly available, the enforcement of smart contracts is unavoidably built-in. Next is trust minimization and guaranteed execution. With smart contracts, there is reduced counterparty risk — that’s the probability one party involved in a transaction or agreement might default on its contractual obligation because neither party has control of the agreement’s execution or enforcement. Lastly, they are more efficient due to automation. Operating on blockchains allows for cheaper and more frictionless transactions than traditional alternatives. For instance, the complexities of cross-border remittances involving multiple jurisdictions and sets of legal compliances can be simplified through coded automation in smart contracts.
Dr. Campbell Harvey, a J. Paul Sticht Professor of International Business at Fuqua, has done considerable research on smart contracts as well, culminating in the publication of a book, DeFi and the Future of Finance which was released in the fall of 2021.
In the book, Dr. Harvey explores the role smart contracts play in decentralized finance and how Ethereum and other smart contract platforms give rise to the ability for decentralized application or dApp. Additionally, smart contracts can only exist as long as the chain or platform they live on exists. However, because these platforms are decentralized, they remove the need for a third party to mediate the agreement. Harvey quickly realized how beneficial this could be in finance, specifically decentralized finance or DeFi where third-party companies, like banks, mediate agreements at a high price.
“Because it costs no more at an organization level to provide services to a customer with $100 or $100 million in assets, DeFi proponents believe that all meaningful financial infrastructure will be replaced by smart contracts which can provide more value to a larger group of users,” Harvey explains in the book
Beyond improving efficiency, this also creates greater accessibility to financial services. Smart contracts provide a foundation for DeFi by eliminating the middleman through publicly traceable coded agreements. However, the transition will not be completely seamless and Harvey also investigates the risks associated with smart contracts and advancements that need to be made for them to be fully scalable.
Ultimately, there is a smart contract connectivity problem. Essentially, smart contracts are unable to connect with external systems, data feeds, application programming interfaces (APIs), existing payment systems, or any other off-chain resource on their own. This is something called the Oracle Problem which Chainlink is looking to solve.
Harvey explains that when a smart contract is facilitating an exchange between two tokens, it determines the price by comparing exchange rates with another similar contract on the same chain. The other smart contract is therefore acting as a price oracle, meaning it is providing external price information. However, there are many opportunities to exploit this such as purchasing large amounts on one oracle exchange in order to alter the price and then go on to purchase even more on a different exchange in the opposite direction. This allows for capitalization on price movement by manipulating the information the oracle communicates to other smart contracts or exchanges.
That being said, smart contracts are being used heavily, and Pratt senior Manmit Singh has been developing them since his freshman year along with some of his peers in the Duke Blockchain Lab. One of his most exciting projects involved developing smart contracts for cryptocurrency-based energy trading on the Ethereum Virtual Machine allowing for a more seamless way to develop energy units.
One example of how this could be used outside of the crypto world is insurance. Currently, when people get into a car accident it takes months or even a year to evaluate the accident and release compensation. In the future, there could be sensors placed on cars connected to smart contracts that immediately evaluate the damage and payout.
Decentralization allows us to avoid using intermediaries and simply connect people to people or people to information as opposed to first connecting people to institutions that can then connect them to something else. This also allows for fault tolerance: if one blockchain goes down, the entire system does not go down with it. Additionally, because there is no central source controlling the system, it is very difficult to gain control of thus protecting against attack resistance and collusion resistance. While risks like the oracle problem need to be further explored, the world and importance of DeFi, as well as smart contracts, is only growing.
And as Ayesh put it, “This is the future.”
Post by Anna Gotskind, Class of 2022