Blockchain Technology – Smart Contracts

Blockchain is best known as the technology which underlies the virtual currency, bitcoin. But Blockchain, a distributed database ledger, has potential applications well beyond virtual currencies.

Blockchain technology may be thought of as a type of operating system for transactions carried out over the internet. It is a means for storing, tracking, trading and verifying assets and information. No central authority (government, regulatory entity) or trusted third parties are required or involved.

Blockchain does not represent new technology but rather combines existing technologies (distributed systems, peer-to-peer networks, hashing functions, public-private key cryptography, cryptographic signatures, elliptic curve cryptography) in a new manner.¹

A “blockchain” is a database of digital transactions that are recorded in chronological and linear order. A group or “block” of transactions can’t be added to a blockchain without verification by network participants that the transactions are valid. Once added to a network, a block cannot be changed or deleted.

Financial institutions are investing heavily in blockchain technology with the goal of creating smart contracts which carry out financial transactions without the inefficiencies and risks created by intermediaries.

Smart Contracts

Bitcoin is a first-generation implementation of blockchain technology.

Smart contracts represent the next generation. A “smart contract” is a contract written in a programming code, recorded on a blockchain. The contract is automatically performed or enforced without the involvement of the contracting parties or a central authority.

Smart contracts have been referred to as “programmable money” or self-automated computer programs that can carry out the terms of any contract.²

To date, smart contracts have been used for cryptocurrency³ trading on platforms such as Ethereum (www.ethereum.org) which supports multiple programming languages used to write smart contracts.

It has been suggested that smart contracts may find application in capital trading markets⁴, real estate and intellectual property transfers, power grid, supply chain and logistics management, and insurance claims processing.⁵

The Expectation Game

Blockchain enabled smart contract technology is attracting the attention of, and significant investment by, established enterprises and start-ups.

But are smart contracts being over-hyped? Unlike bitcoin type blockchains used for finance and business record keeping, to date there is no equivalent for Ethereum smart contracts.⁶

In the view of one com-mentator, the misconceptions surrounding smart contracts don’t involve immature technology or lack of tools, but rather are related to a basic misunderstanding of the properties of computer code.

1. External Input
   The notion that a smart contract can perform a function (code executing an instruction) based on information received by a particular node (blockchain participant) from a source outside the blockchain database ignores the fact that all nodes must agree – but there can be no assurance that all nodes will receive that same information. The blockchain will be “broken” – its integrity compromised.The “workaround” is to rely on a trusted third party to input the external information into the blockchain database so that every node will have an identical copy of the external data – but this involves regular database type operations which defeats the goal of having a decentralized system.
2. Financial Contract Payment Guarantees
   Simply put, smart contracts cannot, for example, automatically pay bond interest coupons with 100% assurance, while simultaneously allowing the bond issuer to use the bond funds, since the funds must “live inside the blockchain” in order to guarantee payment.⁷
3. Confidentiality
   All participants in a blockchain, such as financial institutions, can access data about the transactions between any members; nothing is private. Although smart contracts cannot access other contracts’ data, blockchain members have direct access to the entire data set because all blockchain data is stored on each member’s system.