Shermin Voshmgir: April 8, 2024
While the term “smart contract” has become more mainstream since the advent of first Bitcoin and then Ethereum, it was first coined by Nick Szabo in 1996, and thus precedes the development of blockchain networks. It was in the early days of the Web when Szabo pointed out that the digital revolution would not only create new institutions but could also formalize economic and social relations. That was twenty years before Ethereum saw the light of day, and created a renaissance of this term. Szabo justified the term “smart” with the functionality that comes with digital contracts to be automatically verified and executed: a digital transaction log that automatically executes the terms of an agreement with the aim of fulfilling the agreed contractual terms. Automatic management of relationships and obligations of all parties involved, purely with computer code.
As opposed to traditional contracts, which guarantee contractual security with reactive procedures using instruments of the existing legal system, smart contracts—according to Szabo—could proactively prevent this reactive “after the fact” security through automated mechanisms, by making a potential breach of contract possible but expensive. Szabo pointed out that the reactive procedures of existing legal systems could be minimized but never fully eliminated. To provide for such a level of proactive security, smart contracts should be automatic and (a) observable, (b) verifiable, and (c) enforceable. In any case, Szabo warned that (d) the privacy of the data must be guaranteed by only revealing necessary data, and only to contracting parties that are entitled to view it.
Szabo was very specific in his descriptions of how to technically formalize these relationships, and listed a variety of cryptographic methods that could be used, such as public-key cryptography and digital signatures, and in particular, blind signatures and zero-knowledge proof cryptography. Some of these cryptographic methods described by Szabo can be found in the implementation of Bitcoin. However, Szabo was much more far-sighted in his thought processes than Satoshi and many other early developers of Bitcoin and alternative blockchain networks, such as Ethereum. While he was referring to more privacy-preserving methods like blind signatures and zero-knowledge proofs back in 1996, these methods are only slowly finding their way into the blockchain world. Such privacy-preserving techniques also have the potential to meet the requirements of “Privacy by Design,” specified in the General Data Protection Regulation (GDPR) of the European Union, much better than the cryptographic methods that are currently used in most state-of-the-art blockchain networks (read more: Part 1 - Cryptography).
Szabo said that for smart contracts to “be embedded in the real world in the form of self-enforcing code,” they must be designed to be trustworthy and attack resistant, both against intentional attacks and against unintentional vandalism. However, at that time, Szabo had no idea how to fully decentralize trust and make such a system sybil attack resistant, and therefore described the necessity of a trusted intermediary. He described the economic utility function of a potential attacker and referred to concepts of theoretical computer science and information security when outlining solutions. In 1998, he went on to develop his ideas around smart contracts into real life implementation of P2P value transfer. He came up with an idea for electronic cash that would be as inflation resistant as gold, which he called “Bit Gold.” Bit Gold was never implemented because Szabo didn’t find a way to replace the trusted intermediary with a sybil attack-resistant system. Ten years later, Bitcoin’s major breakthrough was addressing exactly this issue with the introduction of “Proof-of-Work.”
Szabo envisioned an entanglement of different scientific fields in order to formalize smart contracts, such as law, economics, and cryptography, but criticized that these disciplines hardly communicated with each other. However, he was not the first to think about contractual automation. Two years earlier, Ian Grigg described his thoughts on Ricardian Contracts, specifying how to make real-world contracts machine readable and machine enforceable. He wanted to create a system that would allow maintaining human readability of contract intentions as well as resulting actions, before an agreement is executed, while optimizing machine authentication and processing through encryption techniques, such as hash functions and digital signatures. His aim was to guarantee the linking and processing of legal documents and related matters to provide more transparency and security than traditional legal procedures. The first hybrid solutions of smart contracts and Ricardian Contracts exist. “Openbazaar” is a P2P e-commerce platform that is already working with Ricardian Contracts.
Since the advent of the Ethereum project, the term “smart contract” has experienced a renaissance. Ethereum decoupled the concept of programming smart contracts from the underlying blockchain network processing the agreements. As opposed to Bitcoin, the Ethereum protocol aims to provide a cost-saving infrastructure where one can create any type of smart contract with just a few lines of code. Ethereum inspired many more projects to work on similar smart contract blockchain networks, such as EOS, Cardano, or Solana - all of which have varying degrees of technical maturity, scalability, network security, and often use different smart contracting languages.