Crypto: Are Smart Contracts a blessing or a curse for fraud prevention?

When it comes to fraud prevention, technology has always been a double-edged sword. 

We have tools that make our lives safer and more efficient; those same tools can create new opportunities for malign actors, too. 

One of the most prominent developments in recent years in this area has been the rise of “smart contracts”, essentially self-executing agreements powered by blockchain technology.

But are they really the fraud-proof solution they’re hyped to be, or do they come with risks of their own?

Why Smart Contracts are great for fraud prevention

If you’re new to the concept, smart contracts are essentially programmes that automatically execute actions when certain conditions are met.

A smart contract is like a digital vending machine on the blockchain, which automatically enforces an agreement based on a set of predefined rules. 

For example, if you send $5 in cryptocurrency to a vending machine’s smart contract address to buy your morning cappuccino, the contract verifies the payment and delivers a coffee without needing a middleman.

In reality, of course, smart contracts are used in much more complex transactions than simply purchasing your morning cuppa. They’re like traditional contracts, but written in code and stored on a blockchain: transparent, secure and self-enforcing.

Here’s why many consider them to be a fraud-prevention game-changer.

Impossible to tamper with

Smart contracts live on the blockchain, which is immutable (“can’t be changed”). Once the contract is deployed, neither party can tweak or edit the terms. This means no shady business, such as sneaking in changes after the deal is signed.

No middlemen, no problem

You don’t need a third party to enforce smart contracts: they handle themselves. The process of Escrow is automated, and the conditions are checked and executed. By cutting out intermediaries, you reduce the risk of human error or corruption.

Built in accountability

Every transaction and interaction with the contract is recorded on the blockchain. This means a clear, auditable trail, which makes fraud or disputes much easier to detect.

Always fair, always on

Smart contracts don’t play favourites or take bribes, they operate with complete neutrality. They’re designed to follow the rules you’ve written into them and can’t be swayed by external influences. They remain secure, transparent and resistant to manipulation. 

But there’s a dark side

As impressive as smart contracts are, they’re not perfect. In fact, their greatest strengths can also become their biggest weaknesses. Let’s look at how these vulnerabilities have played out in the commercial world.

Code is Law, but what if the code is flawed? 

A smart contract is only as good as the person who wrote it. If there’s a bug or vulnerability, it can be exploited.

For example, in July 2023, the Crema Finance decentralised exchange suffered a $9 million exploit when a security engineer manipulated pricing data through a vulnerability in the smart contract. This incident demonstrated how flawed code can have devastating financial impacts if not properly audited.

No undo button

Blockchain’s immutability cuts both ways. If something goes wrong – whether it’s a coding error or a fraudulent input – it can’t simply be reversed.

This was evident in the SafeMoon liquidity pool breach of March 2023, where hackers exploited a flaw and drained nearly $9 million worth of tokens. Even though a portion of the stolen funds was returned, the incident underscored the difficulty of recovering funds after a smart contract exploit.

The human factor

While smart contracts are secure, the people using them aren’t always. Social engineering scams, phishing attacks, or fake contract links can trick users into approving fraudulent transactions. 

This risk was amplified in the Forsage case, where founders of a smart contract-based DeFi platform used a pyramid scheme to defraud investors of $340 million. By exploiting trust in the “self-executing” nature of the platform, bad actors demonstrated how even secure code can’t protect against fraud if humans are misled.

Legal ambiguities

Let’s face it, just as with laws in the digital asset space, laws around smart contracts are still catching up. 

What happens if fraud occurs across borders? Who has jurisdiction? And how do courts handle disputes when the terms are written in code rather than legalese?

Cases like Forsage also highlight the complexities of enforcing legal action when fraudulent schemes span multiple countries.

Fraudsters can still hide

While blockchain transactions are transparent, they’re also pseudonymous. This can make it tricky to trace the real identity of bad actors using the system.

For instance, in the case of Crema Finance, while the attacker was identified and later arrested, not every case of fraud ends with the perpetrator being brought to justice.

So, are Smart Contracts a blessing or a curse?

The answer depends entirely on how they’re designed, implemented and managed. 

When used correctly, smart contracts are an incredibly efficient tool for automating transactions and preventing fraud.

However, without careful oversight, they can introduce vulnerabilities that malicious actors may exploit: much like locking the front door while leaving the back door wide open.

Here are some ways to ensure smart contracts live up to their potential.

Get the code right

Smart contracts are immutable after deployment on the blockchain. Errors in the code can lead to financial losses or vulnerabilities. Conducting rigorous audits using professional services such as CertiK, OpenZeppelin or Trail of Bits, is an essential process. Utilising formal verification methods to mathematically prove that the code performs as intended is an important process to undertake.

Add a safety net

The Compound protocol, built on the Ethereum Blockchain, includes a “pause guardian” feature that allows the system to be paused during emergencies, preventing further transactions until issues are resolved. Incorporate “kill switches” or admin rights with multi-signature wallets to act as an emergency stop mechanism.

Educate users

Phishing scams have become a growing issue in decentralised finance (DeFi). Fake wallet apps have tricked users into sharing private keys, allowing hackers to empty wallets. Deploy user education campaigns alongside technical solutions. Teach users to verify URLs and smart contract addresses before interacting with platforms.

Work with the law

A lack of regulatory clarity can create legal ambiguity, deterring adoption or exposing developers to unforeseen liabilities. Governments are starting to adopt blockchain-based systems. Estonia uses blockchain for e-residency and notarisation. Advocating to clear regulations can ensure compliance and harbour trust.

Combine tech and tradition

Smart contracts can handle automatic payments for freelancers while incorporating traditional legal contracts to address disputes over the scope of work. Platforms like Kleros use blockchain-based arbitration for disputes that require subjective judgment.

The verdict

Smart contracts are neither a perfect shield against fraud nor a ticking time bomb. Instead, they’re a powerful tool that can make transactions safer and more efficient when handled with care. 

Their transparency, automation, and security give them a clear edge in fraud prevention, but their flaws remind us why human oversight will always be essential.

While smart contracts have demonstrated immense potential to revolutionise transaction automation and fraud prevention, their current state leaves much to be desired. 

More robust ecosystem

The immutability of blockchain, while a core strength, exacerbates the consequences of poorly written or vulnerable code, as demonstrated by numerous high-profile exploits. A more robust ecosystem demands advanced tooling for formal verification, ensuring the mathematical correctness of smart contract code before deployment.

Additionally, the integration of oracles, external data providers critical to the functionality of many smart contracts, remains a significant weak point, introducing vulnerabilities through centralised or unverified sources. 

Bridging this gap will require decentralised oracle networks with robust validation mechanisms to prevent data manipulation or inaccuracies.

Furthermore, regulatory ambiguity surrounding smart contracts poses challenges for global adoption and enforcement. Establishing internationally recognised frameworks for dispute resolution, legal enforceability, and liability in cases of failure is paramount.

Still in its infancy

In essence, smart contracts are still in their infancy, and their scalability, security, and legal frameworks require significant development. Without addressing these gaps, technology risks undermining its transformative potential.

The path forward will necessitate interdisciplinary collaboration between developers, security experts, and regulators to ensure that smart contracts fulfil their promise as a reliable cornerstone of decentralised ecosystems.

The Forsage, Crema Finance, and SafeMoon cases are a stark reminder that while smart contracts offer incredible potential, they require thoughtful design, diligent monitoring, and robust legal frameworks to truly succeed.