What Do Smart Contracts Have to Do with Alternative Investments?

December 7, 2021

These days, it seems like every cryptocurrency is adopting smart contracts as a way to make themselves more appealing to investors. Bitcoin, the reigning king of cryptocurrency, recently launched the Taproot update which has one crucial benefit: unlocking the potential for smart contracts.

Which begs the question: what is all the fuss about smart contracts? And are they worth the investment hype?

Here’s a look at smart contracts, alternative investments, and what they mean for investors.

What are Alternative Investments?

First, it helps to cover the basics.

Alternative investments are a broad investment category covering any investment that doesn’t fall into one of the three conventional categories:

  1. Stocks
  2. Bonds
  3. Cash

In other words, anything that isn’t stocks, bonds, or cash can technically qualify as an alternative investment. This includes a huge array of investments from fine art to fine wine to real estate to gold to distressed securities to hedge funds.

However, all alternative investments have a few key features in common: they’re more complex, less liquid, and less regulated than their conventional counterparts. For example, how do you value a 1933 Saint-Gaudens Double Eagle $20 gold coin? You’d have a hard time of it, since there are only 13 known to exist, and that uniqueness and valuation difficulty are common features that contribute to the complexity and illiquidity of alternative investments.

What is Blockchain?

Because cryptocurrencies don’t fall into one of the three conventional investment categories, they are considered alternative assets. Smart contracts are part of cryptocurrencies—or rather, an offshoot of blockchain technology, the network cryptocurrencies rely on.

Blockchain is a decentralized, immutable database shared across nodes of a computer network. Unlike most databases, which rely on spreadsheets, blockchain uses a list of transactions (blocks) in one sequential list (chain) to essentially form a single never ending receipt. And unlike most databases, blockchain transactions cannot be edited after they’ve been entered into the chain. Every user validates new transactions, so in order to hack and modify a single transaction, you would have to hack the entire chain—no small feat considering that new blocks are being added all the time.

This makes it an essential technology to support cryptocurrency, since cryptocurrency has no physical equivalent, nor any ties to a national currency or national bank. Blockchain ensures that fraud and double-spending are all but impossible.

What are Smart Contracts?

This brings us to smart contracts, the new buzz in cryptocurrency investing (and beyond).

Smart contracts are a simple concept. Each contract isn’t a contract at all, but simply a program running on the blockchain designed to self-execute once certain conditions are met. They’re usually used to automate the execution of an agreement so that both sides can be assured of the outcome—an important feature in cryptocurrency, which relies on a trustless environment (I.e. an environment where trust is not required for the system to succeed).

How Smart Contracts Work

A smart contract is a computer program, lines of code acting on simple if/then statements. The blockchain network uses these if/then statements to execute the code when conditions in those statements are met.

For example, let’s say you want to execute a transaction verified by a smart contract. The code might contain an if/then statement such as, “If x product is delivered and notarized by Mr. John Doe, then y funds from Ms. Jane Doe will be released to z account.” Once the transaction is completed, the blockchain is updated, though only participants can see the results.

Each contract can carry as many stipulations as the participants would like. All involved participants have to agree on the stipulations and how they’re written into the code. They also have to explore all possible exceptions and establish avenues for resolving a dispute.

How it All Comes Together: Smart Contracts, Alternative Investments, and Investors

So, what do smart contracts mean for alternative investors? At present, they’re lauded as one of the most important applications of blockchain technology—and an exciting avenue to enable alternative investment transactions.

The design of smart contracts means that essentially any field that touches contract law could apply. In fact, the coding of smart contracts makes them more secure and convenient than traditional contracts (not to mention cheaper, which is nothing to sneeze at if you’re looking at alternative investment fees). Plus, they’re a good way to track transactions without the need for trust.

Should You Invest in Smart Contracts?

That said, smart contracts are not a silver bullet for every challenge attached to alternative investments. If anything, the case of the Decentralized Autonomous Organization is a reminder that while smart contracts are exciting, they’re not necessarily more trustworthy than regular contracts, nor are they a replacement for good old fashioned due diligence.

Do smart contracts have promise? Absolutely. Are they flawless? Absolutely not. Either way, smart contracts remain one of the most exciting new directions for blockchain technology, and if you are interested in investing in blockchain technology, smart contracts may be worth the investment. Or, if you’re looking for investment security, the smart use of smart contracts may be worth your time.

Make the Most of Your Alternative Investment Portfolio

Smart contracts are an exciting new avenue for alternative investors, but they’re far from the only option on the market. Sometimes, it pays to invest in alternative investments with staying power—like blue-chip art, which has outperformed the S&P 500 by 180% from 2000 to 2018.

That’s where we come in. We’re the only platform that allows investors to purchase shares in authenticated multi-million-dollar artworks (backed by research from our expert team and our partners at Citi Bank and Bank of America). We handle the research, authentication, and purchasing for you, so all you have to do is purchase shares and collect your dividends when we make a sale. Sound good? Then fill out your membership application today to learn more.

Masterworks is a fintech company democratizing the art market. Our investors are able to fractionally invest in $1mn+ works of art by some of the world's most famous and sought-after artists.