A smart contract is an application that uses the blockchain and acts as a digital contract backed by a set of rules. Smart contracts are not considered contracts in the legal sense in most jurisdictions. It is simply an application that meets the formal requirements and runs on a distributed blockchain system. The result of the execution of the smart contract can be an exchange of assets between the parties. Smart contracts ensure that transactions are transparent, traceable and unalterable.
Smart contracts have a wide range of use cases, not only in the financial sector, but also in other sectors. Smart contracts make it possible to create communication protocols that do not require a priori trust between the parties. Participants can be assured that the contract will only be executed if all the conditions stipulated therein are fulfilled. Additionally, smart contracts eliminate the need for intermediaries, which significantly reduces the expense of completing transactions.
Each blockchain can use its own way of implementing smart contracts. For example, the Solidity programming language is used to create smart contracts on Ethereum networks. In addition to the code, smart contracts contain two public keys, one of which is provided by the creator of the contract and the other is a digital identifier unique to each smart contract.
Immutability of smart contracts
Since smart contracts operate within an immutable decentralized blockchain network, their results cannot be tampered with in the name of illicit profit. But immutability is not only an advantage but also a disadvantage. For example, in 2016, cybercriminals hacked into the decentralized autonomous organization The DAO and stole millions of dollars from Ethereum by exploiting vulnerabilities in smart contract code. Because the DAO smart contract was immutable, developers could not fix the code.
As a result, the Ethereum network decided to reverse the situation at the time of the hack and return the funds to the owners. The corresponding fork is part of the current Ethereum blockchain. The original blockchain, which was given the name Ethereum Classic, did not react to the hack in any way because the course of events in the blockchain must never change.
Heavy reliance on programmer skills and bug sensitivity
Well-written smart contracts are believed to be nearly impossible to hack and are the most trusted way to store documents in the digital world. Yet all code is written by human programmers who can make mistakes. Since a smart contract is visible to all blockchain users, its possible vulnerabilities are also visible throughout the network, and it is not always possible to eliminate them due to its immutability.
In an ideal world, smart contract development should only be done by experienced programmers, especially when dealing with sensitive information, personal data, or large sums of money. In reality, a considerable percentage of errors are caused by the human factor.
One of the reasons that cause vulnerabilities is the complexity of designing, developing, and testing smart contracts. Compared to simple smart contracts, complex contracts tend to have a higher probability of errors due to their complexity. Vulnerabilities and bugs can lead to the theft of funds, their freezing, or even the destruction of the smart contract.
Long-standing known bugs cause many vulnerabilities:
1. Recursive call: The smart contract calls another external contract before the changes are confirmed. However, after that, the outer contract may recursively engage with the initial smart contract in an unauthorized manner because its balance has not yet been updated.
2. Overflow: A smart contract performs an arithmetic calculation, but the result exceeds the storage limit. This can cause amounts to be calculated incorrectly.
3. Preemption: Poorly designed code contains information about upcoming transactions that third parties can exploit for their own benefit.
The effectiveness of smart contracts
Optimizing the performance of a smart contract is an indicator of developer skills. Some contracts, to fulfill their function, produce complex series of transactions, and the commission for these operations becomes high. Effective contracts can significantly reduce transaction costs.
The issue of commissions is closely related to security because a situation where the funds are permanently locked in the contract is, from a practical point of view, little different from situations where they are stolen. Here, monetary losses and vulnerabilities are caused by the same factor – developer negligence.
Ethereum virtual machine
The Ethereum Virtual Machine (EVM) acts as a centralized 256-bit “computer” where all transactions are processed and stored locally by each node on the network in a synchronized manner. As EVM is capable of executing various arbitrary commands, it is susceptible to exploitation. This vulnerability has the potential to disrupt the functionality of smart contracts. Additionally, smart contract code can overload the virtual machine and slow its performance, disproportionately to the commission charged to perform these operations. Despite ongoing research efforts to address this issue, it remains a significant concern.
Smart Contract Security Audit
In order to mitigate potential risks, it has become common for smart contracts to undergo a security audit. There is no one-size-fits-all approach to auditing and each auditing firm applies it at their discretion. The determinism of smart-contract code execution makes security testing work anywhere, extremely easy to support, and also makes incident investigation reliable and indisputable.
Auditors study the smart contract code, write a report and submit it to the project manager. This report includes information about bugs and the work done to resolve performance and security issues. Additionally, a report usually contains recommendations, examples of redundant code, and a full analysis of coding errors.
A large part of auditing includes checking contracts for vulnerabilities. Although some problems are apparent, many errors can only be eliminated with the help of sophisticated tools and strategies. For example, a faulty smart contract can be attacked in conjunction with market manipulation. To detect these problems, auditors perform pentests. Smart contract security auditing prevalent in decentralized financial (DeFi) ecosystems and among crypto skaters. As cryptocurrency experts at the RSTAKING staking platform state, a decision to invest in a blockchain project can be partially based on the results of smart contract code verification.
Without a doubt, smart contracts have had a huge impact on the cryptocurrency world and have revolutionized blockchain technology. Due to the permanent nature of blockchain transactions, the security of smart contract code is of utmost importance. Blockchain technology makes it difficult to return funds and resolve issues after the incident, so it is best to identify potential vulnerabilities in advance.