How Smart Contracts Can Protect Your Investments
Our earlier blog series discussed why on-chain investing is superior. The key component of on-chain investing is smart contracts—this blog takes a closer look at their characteristics and benefits.
"There are three things you cannot escape: death, taxes, and smart contracts."
-Ledger
A smart contract is an Ethereum account with a 42-character hex address—just like an Ethereum wallet address, but with key differences. It does not have a private key/public key pair because the owner of a smart contract is the Ethereum wallet address, rather than an external user. The “owner” can execute the contract's code, but the contract’s code cannot be changed once it is deployed. Ethereum smart contracts are stored in the Ethereum Virtual Machine (EVM) state database and are referenced using the account's codeHash field. However, smart contracts are not entirely free, and they do have limitations.
There is a storage cost to create a smart contract account as opposed to creating a free private key/public key account (a.k.a externally owned account). However, once created, smart contracts are deterministic and leave little up to interpretation, which is an advantage compared to traditional contracts. The availability of smart contracts, coupled with their deterministic nature, allows investors to verify the contract’s code before deploying assets. They are limited to interacting with other blockchain assets/accounts, such as wallets or other smart contracts. So websites and other off-chain entities cannot interact with a smart contract. Lastly, smart contract transactions only occur in response to receiving a transaction.
Benefits of Smart Contracts
Traditionally, a contract between two people is stored by attorneys, an online website such as eBay, or a public entity such as your local county recorder's office. Then the contract is administered and/or enforced by an intermediary, such as the attorneys that drafted the contract, the original online service, or your local city attorney's office. In contrast, smart contracts leverage blockchain technology to store and manage agreements between entities, which results in extreme transparency and improved efficiency. When certain predefined conditions are met, various functions are carried out as specified by the smart contract code, all without requiring an intermediary to manage or enforce it.
Smart contracts have a wide range of applications, such as managing digital rights; defining rules that govern the transfer of digital assets such as tokens; or interacting with other smart contracts such as NFTs (digital art or representations of a physical asset). For example, OCI’s smart contracts allow clients to buy various combinations of ERC-20 tokens composing an index fund that is managed using a smart contract. Another example is the Beacon Chain staking contract, worth $18.95 billion, which is the highest-valued Ethereum smart contract. Since it is fully on-chain, all details can be audited and verified 24/7 by viewing the contract details on Etherscan. From contract-to-wallet transactions, to contract-to-contract transactions creating networks of interacting smart contracts, the possibilities are endless and new use cases are constantly emerging.
As mentioned in our earlier blog, on-chain digital assets are commonly stored and controlled by intermediaries such as investment firms and centralized exchanges. Reliance on intermediaries inherently obfuscates the actual state of deposits due to reduced transparency. However, when using smart contracts to invest, blockchain technology (decentralized, transparent, permissionless architecture) benefits the investor. This provides investors with unrestricted access to view and audit their investments in real-time, including balances, transactions, and smart contract code that governs transactions. Additionally, smart contracts protect investors from unsolicited movement of funds, since transactions only execute after specific preconditions are met.
