Ethereum and the World of Smart Contracts

The cryptocurrency Bitcoin has gained significant mindshare and much notoriety:  with a market value of about $10 billion it is not a trivial currency, although it represents only the tiniest fraction of the world economy.  The likelihood of cryptocurrencies such as Bitcoin replacing existing currencies seems remote, but the underlying technology that powers these currencies – the blockchain - remains a potentially disruptive and transformational technology. 

The Bitcoin blockchain implements a distributed peer-to-peer ledger system that allows tamperproof records of transactions without the single “database of record” that underlies most of our existing transactional systems. However, it’s widely accepted that to realize the full potential of blockchain technology we will need a next-generation blockchain to supplement the one provided in the Bitcoin implementation. 

Ethereum represents just such a next-generation blockchain.  Ethereum can host cryptocurrencies such as Bitcoin and has its own cryptocurrency – Ether.  However, the major innovation within Ethereum is the implementation of a Turing complete compute engine within its blockchain.

“Turing complete” is a fancy way of referring to any general purpose computing device.  Your PC, your iPad, your TV, and perhaps even your watch are all Turing complete. The difference with Ethereum is that this Turing complete engine is hosted in the same distributed peer-to-peer network that hosts the Ethereum blockchain. Code running on this blockchain is effectively tamperproof and can execute cryptocurrency transactions. 

For instance, I could write a very simple program in Ethereum that says if you send me $10 worth of Ether, then in 1 year I will send you back $11. You could be certain of receiving your $11, providing I had at least $11 in my account. Once I establish the program it cannot be revoked or changed. Such programs are referred to as smart contracts, and they can implement a huge variety of applications: Games, voting, property agreements, proof of identity, royalty payments and so on.

Advocates of Ethereum argue that a legal contract is essentially a poorly worded set of instructions, that can be far more efficiently and unambiguously represented in code. They believe that one day the majority of contracts will be smart contracts running on something like Ethereum.

Indeed, entire organizations - Decentralized Autonomous Organizations (DAO) - could be constructed entirely from smart contracts. Such organizations would have no human leadership: their actions would be completely determined by smart contracts.

“The DAO” was such a Decentralized Autonomous Organization – it was created in April 2016 as an investor controlled VC fund operating entirely under Ethereum smart contracts.  Investors contributed funds to the company using the Ether cryptocurrency which gave them the right to vote on investments through an application based on Ethereum.   Unfortunately, hackers found a bug in the open source Ethereum code controlling “The DAO” and temporarily stole about $50 million worth of cryptocurrency.   The hack was reversed through a non-reversible fork of the Ethereum blockchain which reversed the hacked transaction and returned currency to “The DAO.”  

This exploit and the extreme measures needed to correct it illustrate that organizations run by smart contracts will be far from infallible.   Errors in legal contracts can result in ambiguity and dispute, but eventually can be resolved through a human judge determining the intent and fairness of a contract. Errors in Ethereum smart contracts will normally have no such recourse: the hard fork that resolved “The DAO” issue cannot possibly be widely applied, and indeed will become increasingly technically difficult as the Ethereum blockchain extends.

Ethereum also has significant scalability issues relating to the underlying peer-to-peer architecture and is capable of executing only dozens of transactions per second, a far cry from what would be necessary if smart contracts became the norm.

Despite these drawbacks, the Ethereum smart contract concept smells like the future.  Many – myself included – believe the blockchain technology represents a fundamental technology that will revolutionize commerce, and smart contracts built upon blockchain may well disrupt and revolutionize many forms of binding legal agreements.