The use of smart contracts, which originated on the Ethereum blockchain, is very much in vogue right now as use cases expand beyond the crypto universe.
Smart contracts are programmes stored on the blockchain that run automatically when predetermined conditions are met. They are typically used to automate the execution of an agreement so all participants know the outcome from the outset. Smart contracts eliminate the need for an intermediary to verify or execute a transaction, remove any human bias, and are traceable on the blockchain.
Using a smart contract has a range of benefits, making them attractive to the crypto community and many other industries.
A smart contract removes the risk of third-party manipulation because you don’t need an intermediary to corroborate an agreement. There are set, pre-agreed rules that will trigger the contract once met.
Smart contracts are executed automatically when certain conditions are met, unlike regular agreements, which need time to draft, negotiate and sign. Payment is also immediate on the execution of a smart contract, with no need to wait for an invoice.
Zero third-party involvement means smart contracts are generally cheaper to run than traditional methods. Of course, it wouldn’t be wise to do away with a lawyer’s input altogether, as any contract still needs to be legally compliant. However, the manual effort in putting a contract together should reduce, along with the cost.
As smart contracts exist on the blockchain, they are immutable and publicly available for anyone to see. Mistakes in execution are avoided, and the contract is immediately viewable and recorded, enhancing trust between parties.
Smart contracts are encrypted to prevent unauthorised access and so are hard to hack. Each one is linked to other records on the blockchain, and hackers would have to change the whole chain if they wanted to alter the smart contract record.
As with any technology, there are vulnerabilities that need addressing to ensure smart contract users are kept safe and receive the desired outcome.
The immutable nature of a smart contract can be both a disadvantage and an advantage. It means any mistakes are time-consuming, expensive, and super challenging to address, removing any flexibility from the process. This can result in smart contracts being more complicated than needed, especially on a straightforward exchange.
If there are loopholes in a smart contract, then there’s an opportunity for fraudsters to exploit them and steal crypto assets. Unfortunately, stolen funds are usually difficult to track and recover, and unlike traditional finance, there is no protection for the user from a regulator.
Mistakes can be made in the coding of a smart contract as you rely on a coder to ensure the contract terms are correct. For example, not performing input validation correctly could let hackers introduce malicious code into the contract.
It’s well known that some of the most significant crypto losses of recent times are down to smart contract vulnerabilities, causing crypto owners to rethink their investment strategies. As a result, security is high on the agenda for exchanges and custodians, with smart contract creators taking precautions to improve security.
Following blockchain and development best practices will reduce the risk of loopholes in smart contracts. A secure environment for coding, testing and deployment is necessary, as is using code version control. Test code thoroughly, and make sure it’s comprehensively documented.
Getting a third party to conduct a code review or setting up a bug bounty programme will help identify vulnerabilities in contract code.
Investing in a security toolbox and technical training for coders can help protect against common vulnerabilities such as Denial of Service attacks or reentrancy attacks.
It’s not only smart contract creators reviewing their security. Crypto asset service providers who understand the importance of protecting their customers’ transactions can screen them to identify suspicious transactions. Coincover’s transaction monitoring technology, for example, uses a crypto threat intelligence database with machine learning models to monitor transactions to prevent theft, hacks and scams continuously. If an unusual transaction occurs, an alert is sent to the sender, who can review the transaction and decide whether to allow it.
While smart contracts originated in and are used in the crypto world, they can be used in many industries to execute agreements. Let’s take healthcare, for example. There are a growing number of use cases for smart contracts, from improving patient record data to ordering and paying for medical equipment in the supply chain. Other uses include general supply chains, property transactions, stocks and shares trading, and lending.
Unfortunately, smart contracts haven’t escaped regulators’ attention. In Europe, Article 30 of the European Parliament Act mentions the need for robust controls for smart contracts to prevent functional errors and manipulation by third parties. It also sets out the requirement for a ‘kill switch’ to terminate the execution of transactions. While it would add an extra layer of security, it goes against the purpose of a smart contract – autonomy and the removal of third-party participation.
As with digital assets overall, smart contracts will likely come under increasing scrutiny from regulators. As a result, further controls will be put in place, and smart contracts will have to adapt to meet the new requirements.
If you’re interested in learning more about protecting your transactions with our transaction monitoring technology, let us know, and one of the team will be in touch soon.