Smart Contracts: Building Blocks for Digital Markets
Copyright (c) 1996 by Nick Szabo
“…New institutions, and new ways to formalize the relationships that make up these institutions, are now made possible by the digital revolution. I call these new contracts “smart”, because they are far more functional than their inanimate paper-based ancestors. No use of artificial intelligence is implied. A smart contract is a set of promises, specified in digital form, including protocols within which the parties perform on these promises.
The basic idea of smart contracts is that many kinds of contractual clauses (such as liens, bonding, delineation of property rights, etc.) can be embedded in the hardware and software we deal with, in such a way as to make breach of contract expensive (if desired, sometimes prohibitively so) for the breacher. A canonical real-life example, which we might consider to be the primitive ancestor of smart contracts, is the humble vending machine. Within a limited amount of potential loss (the amount in the till should be less than the cost of breaching the mechanism), the machine takes in coins, and via a simple mechanism, which makes a beginner’s level problem in design with finite automata, dispense change and product fairly. Smart contracts go beyond the vending machine in proposing to embed contracts in all sorts of property that is valuable and controlled by digital means. Smart contracts reference that property in a dynamic, proactively enforced form, and provide much better observation and verification where proactive measures must fall short. And where the vending machine, like electronic mail, implements an asynchronous protocol between the vending company and the customer, some smart contracts entail multiple synchronous steps between two or more parties.
Other forerunners of smart contracts include POS (Point of Sale) terminals and cards, EDI (Electronic Data Interchange, used for ordering and other transactionsbetween large corporations), and the SWIFT, ACH, and FedWire networks for transferring and clearing payments between banks. These implement commercial security models, but too often with little heed paid to the contractual needs and obligations of the parties….”