Starting with smart contracts, the concept goes back to the 90’s, when Nick Szabo first published “Smart Contracts: Building Blocks for Digital Markets”. Here were the first definitions provided to the distinctive nature of these future contracts. They reside in the digital space because smart contracts can provide more functionality as opposed to the static paper-based version of contracts we are still currently dealing with in business and in personal matters. The basis for smart contracts to thrive are computers and a network that distributes programmable algorithms, yet as of today, they have seen little adoption. With the introduction of blockchain technology, its foundations in mathematics, and its crypto-graphic protocols, there is now the fundamental trustless layer on which smart contracts can be executed with a higher level of security, so that the results are not corrupted or altered, as might have been the case before: Programmability merges with the blockchain.
This was the birth of the Ethereum blockchain. Its main purpose was to bring smart contracts to a trustless blockchain platform. It was a revolution at the time and it came with a lot of acceptance, not only from dedicated individuals but also start-ups, bringing ideas and business concepts that were created to live and interact with the Ethereum blockchain. However, as mentioned in the previous post, the trilemma caught up and the scaling issues of the blockchain hampered further adoption to a large extent. This gap in the smart contract market has allowed many new protocols to jump in and develop their own platforms. None have been able to reach any sort of mass adoption up to date.
Furthermore, there is a need to overcome the reluctance people may have in using contracts in the form of software in order to govern important transactions. In some of the very early form of these contracts, there were bugs and even hacks leading to very negative outcomes. This overall negative impression can only really be overcome once there is more assurance that these contracts work correctly, meaning the tools and methodologies need to be bulletproof. The software development motto “go fast and break things” may have worked in the past but for applications that govern value in blockchains – well, it might not be the best approach. No one wants to be on the loser side of a contract and potentially lose value because of a software bug. Higher assurance principles will be key to gaining confidence and reliability for everyday use, and the platforms that embody these principles, in all aspects of the development, will prosper – not only on the platforms for smart contracts but also in the applications they run on.
- programming language chosen to write the smart contracts platform
- programming methodology
- testing approach – meeting stiff and demanding quality requirements
- outcomes of the contract as well as assurance
- cost of executing the contract.
- Regular audits to the programming developments by independent third-party security auditors; smart contract quality certifications are some of the best-practices we believe will populate the smart contract industry, with the expected outcome of generating more trust in the use of these applications by the end consumer.
An equally important development and watershed moment will be the regulatory positioning of smart contracts to the existing environment. There is a need for clarity as to how smart contracts will be a considered form from a legal point of view.
These very foundational concepts will require a lot of clarifications and the incentives to further develop this industry and promote mass adoption. Latter may hinge to a large extent depending on how the regulatory environment sees and judges the initial developments of smart contracts.
Blockchains as decentralized systems are somewhat closed, since they record value exchanges across different addresses in a ledger. These are then recorded as transactions and next they are grouped together in blocks which in the end get added and validated according to a specific consensus algorithm. Smart contracts can programmatically automate the exchanges of value, however with very limited capabilities as we are still working with a closed system. What in fact could elevate the capabilities of smart contracts operating on blockchains, would be having access to data from outside the blockchain: weather data, prices of assets, location data, time, anything you can imagine. The question that follows up on this is:
If we are operating a trustless decentralized blockchain system, how do we extend that concept to getting reliable data into the blockchain without a centralized third party?
Oracles are a somewhat trusted middleware connecting blockchains to data from outside the blockchain – more commonly called off-chain data, meaning data which is not on the blockchain. Oracles can clearly enhance the capabilities that smart contracts can provide. Without off-chain data, one only could create a contract to lock some value for a certain period, or automate multiple transactions. With off-chain data these possibilities expand exponentially to contracts that can manage all your weekly payments or can exchange a token for another one, when a certain price or a specific day is reached. The challenges for oracles are like those for blockchains: they need to perform in a decentralized manner.
Centralized oracles can undermine the usage of smart contracts because if the execution of the contract is dependent on a specific data point, and that data point is sourced from a central source, then the advantages of using smart contracts are voided.
Decentralized oracle solutions currently exist, yet we would argue that they are still in very early stages of maturity and there are other business models for oracles to be explored in the future.
Furthermore, there is also a need to analyze how centralized sources of data currently in use and being considered trustworthy, like Bloomberg or Wolfram, can interact with blockchains through oracle middleware.
We believe that the further smart contract platforms evolve, the more applications will be created on these platforms, which leads to more usage, which then will increase the demand for more data to be communicated to the blockchain à resulting in overall growing demand for Oracles.
This process will trigger the market into developing alternative solutions for oracle models such as pools of oracles: mining pools, stake pools, oracle pools. This is a space with significant growth to come in the coming years.
What we have not yet discussed throughout these posts relates to the value that the blockchain is safeguarding and accounting for in the ledger. The initial blockchains coined their value as cryptocurrencies:
Bitcoin for the Bitcoin blockchain,
Litecoin for the Litecoin blockchain and
Ether for the Ethereum blockchain.
However, more generically said they host a native digital token. The token is rewarded through the monetary policy rules of these protocols whenever a miner creates a block. The introduction of this tokening mechanism to blockchains and the alignment of incentives of the protocol for users to accumulate these tokens have uncovered that blockchains can propel a broader tokenization of the economy than what we currently have.
Nowadays, we have very little liquidity of the day-to-day tokens we accumulate in life, whether it is the supermarket points we gather to receive discounts, the miles we accumulate on our flight or the points we get at our favorite hotel chain. These tokens can only be redeemed in very narrow setting.
We can only redeem our supermarket discount in a particular retail chain. The flight miles can only be redeemed through a specific airline alliance or their affiliated partners. Lastly, the same rules apply to the hotel points we can only receive certain chains of hotels.
- liquidity of these tokens is very poor
- exchange of value takes time and has no velocity to it
Contrast to this scenario is a world where coupons, flight miles, hotel points are all digital tokens generated and tracked on different blockchains. These blockchains talk to each other, meaning there is a degree of interoperability between them, where value can be assigned to exchange one token for another; aka a token market is created. It’s a set of peer-to-peer networks that each have multiple different digital tokens represented on them. The tokens can now be exchanged with much more liquidity than before. The tokens described until here are familiar to us as they are fungible tokens: exchanging one flight mile for another flight mile has the same value. Our everyday money we use to pay for goods and services is a fungible token. The other set of tokens are the non-fungible tokens, where one token isn’t worth the same as the other; think of collectibles or art as classic examples. Blockchains enable the creation of non-fungible token markets where people can exchange digital tokens representing not only physical items but also digital ones. Until now it has been extremely difficult to crystallize clear ownership of a digital asset as it is easily replicable with a simple “copy-paste”. As immutable ledgers, blockchains can now document and trace the digital representation of something back to the true owners and its origin.
Non-fungible tokens are currently a very popular topic. There has never been a foundational layer in place that enables the creation of digital non-fungible tokens (NFTs). Furthermore, marketplaces where these tokens can be exchanged with much more liquidity than the traditional art and collectors’ items auctions haven’t existed either.
Some real-life applications of NFTs come from a variety of different industries. Gaming has long had a reputation of creating non-fungible tokens, but these tokens have been integrated within the games themselves from the very beginning. The player has been dependent on the game developer to keep developing and supporting the game. With NFT’s, the player can keep the control over his in-game items and potentially find an interested peer in an NFT marketplace, even if the game has been discontinued.
Besides collectible items and art, there are even memorable moments being tokenized people can own for themselves, such as video clips of key sporting events, like famous football goals or basketball slam dunks.
Nowadays, digital life is becoming more and more, if not even just as important as our physical lives. Domain names, addresses on the internet are being tokenized and to a far more, extreme extent. Real estate is being commercialized in virtual reality simulations so anyone can now buy virtual real estate in the form of tokens. It only makes sense that digital token economics, coupled with its potential applications, with smart contracts, and the settlement on the blockchain, needs to be monitored and tracked closely in order to understand what new business opportunities may emerge.