Smart Contracts: From Vending Machines to Decentralized Finance

With smart contract capabilities becoming a new norm for blockchain networks, you might be asking: what is a smart contract, anyway?

The term was first coined (pun intended) by Nicholas “Nick” Szabo, the computer scientist and cryptographer who designed a proto-Bitcoin decentralized virtual currency called “bit gold” (all while he was a graduate student at the University of Washington!). Back in 1996, he discussed the creation of digital markets using electronic contracts which, unlike paper contracts, can fulfill themselves.

For Szabo, the analog origin of smart contracts is the humble vending machine. The machine takes money, then spits out an item. The buyer enters into a contract with the operator of the vending machine at the moment they insert the requisite number of coins; from there, the mechanisms inside the machine fulfill the contract on the spot, without anyone needing to intervene. The customer would presumably choose a vending machine with a track record of being reliable, whether through being well-built or through being maintained by a trustworthy organization; meanwhile, the vendor would create a vending machine with defenses and security measures robust enough to resist vandalism or profitably performable exploits.

But while real-world contracts are ultimately guaranteed by a third party — societal structures, an enforcement agency, a judicial system — a digital smart contract is guaranteed by itself. Secured by protocols based on public key cryptography (“useless complicated math problems“), these agreements are much easier to verify than they are to tamper with. And with transactions executing by themselves according to the terms of a contract, all the middle men in traditional systems are gone.

We can see a few intermediary steps between the vending machine and decentralized finance: point-of-sale terminals, Fedwire, and even Steam all are examples of formerly complicated processes being automated and simplified for the customer’s benefit. But these were all still dependent on the user’s trust of the people operating the system; they were still centralized. With blockchain technology, which dispersed oversight and governance of a system to participants in a decentralized network, the ideal first proposed by Szabo could finally come to fruition.

Whether it’s buying a hot new NFT or opening a fully or partially decentralized bank account, you’re feeling the freedom of not needing to place all your trust in the integrity of one particular institution. Just as democratizing a country has resulted in better systems of accountability, so too has democratizing technology led to a world where we no longer need to take powerful people and organizations at their word.

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