There’s Trouble Brewing with Smart Contracts

Smart code enables property ownership with a few lines of code.
Its simplicity leads to a host of financial and legal concerns.
We may see ToS replace smart contracts.

Smart contracts are fast becoming the new bartering system. Gone are the legal and financial barriers to property ownership; In their place are short lines of “smart” code that enable digital transfer of property from one person to another. This might sound like a digital utopia, but the reality is a legal quagmire. The issues are so bad, that Terms of Service (ToS) are likely to replace smart contracts in the near future.

What is a Smart Contract?

A smart contract is code that specifies ownership and the conditions of transferability for Non-Fungible Tokens (NFTs); the code can also keep track of the number of minted NFTs and assign unique identification numbers. Smart contracts are compact, providing just enough information to identify and transfer digital assets. For example, Ethereum’s smart contract contains just three parts: a counter, a constructor, and a single function that allows a user to mint an NFT [1]. Smart contracts are simple, and that’s where the problems start.

The Trouble with Smart Contracts

The code is so simple that “Anyone can write code for a smart contract” states David Birch, writing in a 2021 Forbes article [2]. In other words, you don’t have have to be a programmer to write smart contracts; anyone willing to learn how to code in a smart contract language can write a few lines of basic code and release an NFT to the world. Once NFTs are minted, blockchains are immutable, which means that they cannot be altered or changed. Immutability is often touted as a benefit of a smart contract, but there’s a significant downside: if you release faulty code, there’s no way of knowing ahead of time if your code is secure [3]. You can’t just download a patch; all you can do is fork the code to indicate there has been a protocol change or diversion; you can then update the software to reflect the new rules.

The result is states Birch, “simple apps, written by people who are fallible, that cannot be corrected and that need vigilantes to resolve disputes,” making smart contracts “…one of the worst marketing labels in history.” Law Professor John Garon agrees. Writing in a January 2022 article titled Legal Implications of a Ubiquitous Metaverse and a Web3 Future, he states that smart contracts have a misleading name and should be renamed more accurately as “…automated provisions for digital transactions.” [4]. But renaming the contracts won’t solve their inherent issues, and we may see them completely disappear soon.

Trouble Brewing

Smart contracts lack the protections of traditional legal contracts for the consumer and for companies. The legal ramifications are unclear on this new frontier. Part of the problem, states Professor Garon, is that the internet was built on the premise of Terms of Service (ToS), which provide legal protections for companies, and warranties for consumers in ecommerce transactions. The introduction of a separate system for some transactions is creating a legal uncertainty for both sets of players in the new digital age.

On one side of the metaversial fence you have major players like FAANG (Facebook, Amazon, Apple, Netflix; and Alphabet) controlling and organizing a centralized virtual world; on the other side of the fence is the decentralized virtual world comprised of individuals sharing NFTs through the rules of smart contracts. FAANG and other major players rely on ToS, while the decentralized world of NFTs relies on an environment built on smart contracts and intellectual property rights. Removing the protections of ToS means that companies lose the contingency planning and risk management associated with traditional contracts; while consumers won’t miss scrolling through pages of legalese, they will lose some guaranteed rights and protections. What happens if your smart-contract property gets hacked or stolen? Who compensates you if the server that holds your asset disappears? These questions are not answered by three lines of “smart” code.

This isn’t a vision of the future; there have already been many notable smart contract disasters. For example, the crypto project ICON lost $8 million after a software error allowed users to mint 25,000 tokens for free. Had ICON used a ToS, states Garon, the financial disaster could have been averted. The famous re-entrancy bug in the DAO smart contract led to $60 million in losses [5]. More recently, in 2021, hackers stole $31 million from MonoX Finance, by exploiting a software bug in their smart contracts software [6].

Going Forward

There’s a lot of active research into securing smart contracts, such as using artificial intelligence (AI) to monitor for suspicious activity or identifying software bugs with auditing tools before the smart contract is released [7]. However, these measures won’t stop the demise of smart contracts because of one simple fact : programming errors are unavoidable. While property ownership via legal contracts aren’t infallible, they do grant more security for companies and for consumers. This will probably lead to the adoption of legal contracts to govern virtual property ownership in the near future. Even if we do find a way to make that perfect smart contract, that may not be enough. Mike Orcutt, writing for MIT technology review [8], states “Making sure code is clean will only go so far,” he says. “A blockchain, after all, is a complex economic system that depends on the unpredictable behavior of humans, and people will always be angling for new ways to game it.”