The traditional financial systems are on the cusp of disruption thanks to smart contracts and blockchain technology. Introduced first by Nick Szabo, a computer scientist and digital currency pioneer, in the 1990s, the concept of the smart contract came to the fore after the emergence of the blockchain-based-cryptocurrency landscape.
Pros and Cons of Smart Contracts
Smart contracts are computer programs, or programmable contracts, stored on a blockchain-based platform. They get automatically executed when predetermined conditions or parameters are met. All types of financial agreements can be programmed using smart contracts, including derivatives contracts, escrow agreements, insurance policies, and auction contracts. Once a smart contract is deployed and made operational, human intervention is not needed to execute a transaction.
The elimination of trusted middlemen to authenticate and facilitate transactions is a key advantage of smart contracts. Other advantages include reduction in transaction cost, errors, risk of manipulation, and disputes between parties. However, there are both pros and cons to using smart contracts.
One disadvantage is that contracting parties may not know how to write a smart contract code, and therefore, they will have to depend on those who have the technical expertise. There is always the risk of human error because of that. And the error may result in the smart contract program not performing functions as per text agreements between the parties. Here are the other disadvantages of smart contracts.
Seeking Legal Help Is Difficult
Most traditional text contracts are legally binding agreements. If something goes wrong, contractual parties can take legal help to settle the issue. But when it comes to smart contracts, legal experts cannot help much. They cannot examine the code-only agreements to determine whether there was a breach of contract. Also, blockchain and smart contracts are not yet mainstream terms, and a court may find it difficult to settle disputes about them.
Difficult to Amend or Terminate Smart Contracts
Multisig (short for multi-signature) smart contracts require multiple signatures to process a transaction. For example, funds can be transferred from Party X to Party Y only after multiple people approve the execution of this transaction. But, even if all the parties want to amend their smart contract, they may fail to do that. It is because of the immutable nature of the blockchains. And trying to modify the code can increase the transaction cost and human errors. Similarly, a party cannot terminate a smart contract when he/she notices an error that is harming his/her interests.
Smart Contract Vulnerabilities Not Easy to Fix
As smart contracts now facilitate millions of dollars in transactions, they have come under the radar of malicious users. And most smart contracts are vulnerable to hacking due to flaws in contract design. These flaws cannot be corrected once the smart contract is stored on a blockchain. It is because there is no way to alter or change the data in the blockchain.
Disadvantages do not mean that smart contracts need to be written off. The technology underlying it can be improved and vulnerabilities fixed. And contractual parties need to carefully design their smart contracts.