Smart contracts are neither smart nor contracts. That was (more or less) the title of a popular 2017 article by Edward W. Felten, a professor of computer science at Princeton University. The title shocks most people the first time they see it, but misnomers like “smart contracts” are commonplace in crypto. (Another one is “wallets” because crypto wallets don’t store money; they merely manage cryptographic keys.)
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So what are smart contracts? “We don’t really have a formalized definition for ‘smart contract.’ But informally we do know what a smart contract is. It’s a program that executes on the blockchain,” explains Jason Teutsch, founder of Truebit, a smart contract computational tool.
Why do smart contracts matter?
If a smart contract is just another computer program, why all the hullabaloo? What makes a decentralized finance (DeFi) app different from your bank’s online banking app? And what do investors need to know?
“It not only processes data, but also value. And that’s what makes it different from a traditional computer which only processes data. A smart contract can process money in a trustless way,” Teutsch explains.
Read more: How Do Ethereum Smart Contracts Work?
History of use cases
Nick Szabo coined the term “smart contract” in 1994. One of his theoretical use cases was a “smart lien protocol” for repossessing leased vehicles from deadbeats.
“We can create a smart lien protocol: If the owner fails to make payments, the smart contract invokes the lien protocol, which returns control of the car keys to the bank. This protocol might be much cheaper and more effective than a repo man,” Szabo wrote in 1997.
Eighteen years after Szabo’s musings, Ethereum, the world’s first smart contract platform, was launched. Ethereum’s first uber-successful smart contract use case wasn’t an automated repo man, it was a decentralized autonomous organization (DAO) – an automated entity governed by programmable rules – aptly named, “The DAO.”
The DAO was essentially a decentralized venture fund. It was financed by the largest crowdfunding event in history at the time – $150 million. The DAO was eventually hacked for 3.6 million ether (currently about $5 billion), damping the excitement around DAOs for years.
But the DAO’s crowdfunding success highlighted another use case – initial coin offerings (funding a venture by minting a token that’s sold to investors in exchange for a more liquid token). Initial coin offerings (ICOs) peaked in 2017, raising nearly $5.4 billion across 342 ICOs.
This time, the U.S. Securities and Exchange Commission was the party pooper. It released an investigative report warning the crypto community that sales of digital tokens would be “subject to the requirements of the federal securities laws." That report likely played a role in the chain of events that eventually led to the notorious crypto winter of 2018.
Current use cases
Right before the 2018 crypto winter, non-fungible tokens (scarce and unique digital assets) like CryptoKitties and DeFi platforms like MakerDAO, started picking up steam on Ethereum. Today, NFTs and DeFi dominate many smart contract platforms (although we’re still in the wake of several major DeFi implosions).
Ethereum is no longer the only game in town. Solana, Avalanche, Polkadot and Binance Smart Chain are the new kids on the block (but not the only ones).
“What we’re seeing is that with NFTs a lot of startups are focusing on the Solana ecosystem and, behind that, Ethereum layer one or Polygon. We saw some interest in Avalanche last year, but that seems to be migrating back to Ethereum these days,” says Nic Carter, general partner at Castle Island Ventures, a venture capital firm focused exclusively on public blockchains.
"DeFi'ed insurance is a great idea and I’m excited to see where this product goes," said attorney Mark Billion in Solace’s press release. “But the jury is out on what is covered, and what a policy holder can do in the event that they disagree with any given outcome," warned Billion.
DAOs have made a comeback. ShapeShift, a popular cryptocurrency exchange, became a DAO last year.
“DAOs are emerging from their trough of disillusionment. They are dynamic, they are non-jurisdictional, and they are shockingly powerful. They have no center. They rely on no bank account. They demonstrate anti-fragile, emergent order,” tweeted Erik Voorhees, founder of ShapeShift.
Future use cases
With the number of smart contract platforms growing, and only a handful of use cases flourishing, how much of the $22.5 trillion traditional financial services market can smart contract platforms garner? If we already have DAO venture funds, exchanges and DeFi insurance companies, what can we expect next? Full-service DAO banks, anyone?
“Digital assets have always been a part of our long-term strategy. We are beyond excited to have the ability to offer tightly integrated bank and cryptocurrency services to our customers and Fintech partners,” said Brad Scrivner, president and CEO of Vast Bank, in a statement.
Vast Bank introduced crypto purchases in its banking app last year, but it’s certainly not a full-service DAO bank. Banking is a tightly regulated industry, so going from traditional to DAO banking will likely be a gradual evolution (if it ever happens). It’s also unlikely that all banks will become DAOs, so the future landscape will probably have a diverse roster.
But no matter how you look at it, banking is an $8.58 trillion sector and out of all potential use cases in financial services, it might just be the next big gold mine for smart contract platforms.
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