In 1997 Nick Szabo
coined the term Smart Contracts to describe the digital automation of certain aspects of traditional contracts
A contract is a set of promises agreed by two or more parties. It has been the standard way to formalize relationships in society for millennia.
A contract isn’t limited to paper, but to any promise agreed upon, implicitly or explicitly. For example, we can make an agreement between a client and a freelancer. The freelance promises to deliver on what the client wants. The client agrees to pay the freelance a negotiated fee in exchange. If the freelancer doesn’t provide or the delivery doesn’t perform as the client approved, then there is a breach of contract. The client is then entitled, upon their contract, to withhold the freelancer’s fee.
This is an elementary example, but one we’re very familiar with. In this case, the contract is explicit, but it could also be implicit. Every time you go to a Parking, you implicitly agree to a contract with the parking owner. You can park your car, but in exchange, you need to pay for the use of the space. Upon payment and delivery of the proof of payment, the parking barrier will let you out of the structure.
So you see, in a way, contracts are what binds most of our social interactions. Some of these agreements are formal; others are informal. Some are explicit; others aren’t.
The notion of contracts though entails several problems. The first one is the enforceability. Often, contracts end up in dispute because the parts can’t agree on the performance of the delivery. Other times, one of the parties breaches the contract and cheats the other side.
The second problem is transparency. In some cases, there are some information asymmetries between the parts. One side might have inside information, putting the other part at a disadvantage when negotiating the contract.
Last but not least, there is no universal set of rules that apply on a global scale. The way we negotiate the terms of a contract; the dispute resolution laws; or even the consequences of a breach of the agreement, will vary wildly between jurisdictions, cultures, and continents.
“The basic idea behind smart contracts is that many kinds of contractual clauses (such as collateral, bonding, delineation of property rights, etc.) can be embedded in the hardware and software we deal with, in such a way as to make breach of contract expensive (if desired, sometimes prohibitively so) for the breacher.
Smart contracts go beyond the vending machine in proposing to embed contracts in all sorts of property that is valuable and controlled by digital means. Smart contracts reference that property in a dynamic, often proactively enforced form, and provide much better observation and verification where proactive measures must fall short.” (Emphasis my own)
I can’t but admire Szabo’s prescient mind. Not only did he predicted the potential of cryptography to secure binding contracts, but he also took a pass at the future state of the Internet of Things (IoT).