Smart contracts are a revolutionary technology that brings together law and code to enable transparent and automated transactions in various fields.
A smart contract is a self-executing digital contract that contains the terms of an agreement between two or more parties. It is written in code and stored on the blockchain, ensuring its immutability and decentralization.
Smart contracts are different from traditional contracts because they don't require a lawyer or bank to enforce the terms of the contract. Instead, they utilize codes to automatically follow the rules and regulations listed in the contract.
The concept of smart contracts is derived from the 1990s. In 1994, computer scientist Nick Szabo defined smart contracts as “computerized transaction protocols that execute the terms of a contract.”.
“I call these new contracts “smart”, because they are far more functional than their inanimate paper-based ancestors. No use of artificial intelligence is implied. A smart contract is a set of promises, specified in digital form, including protocols within which the parties perform on these promises.” - Nick Szabo
At that time, the idea was primarily theoretical and not commonly utilized due to technical impediments. However, Szabo’s research provided the impetus for the creation of smart contracts as they are today.
It wasn't until blockchain technology was introduced that smart contracts could be put to use. Blockchain technology provides a decentralized, secure platform for executing smart contracts that eliminates the need for middlemen, and improves efficiency.
After the launch of Ethereum in 2015, smart contracts became very popular. Ethereum’s blockchain platform allows developers to create and deploy smart contracts on a decentralized network, making them accessible to anyone with an internet connection. Ethereum launched a platform to create and execute decentralized applications (dApps) using smart contracts.
Ethereum founder, Vitalik Buterin, explained smart contracts at the DC Blockchain Summit and said:
“In a smart contract approach, an asset or currency is transferred into a program, and the program runs this code. At some point, it automatically validates a condition, and it automatically determines whether the asset should go to one person or back to the other person, or whether it should be immediately refunded to the person who sent it or some combination thereof.”
Ethereum's smart contracts are popular because of their potential uses outside cryptocurrencies. They can be employed for multiple purposes, including decentralized finance (DeFi - read more about DeFi here), supply chain management, voting systems, and more. Their capacity to automate processes, promote transparency and reduce costs makes them a significant component of blockchain-based platforms.
Smart contracts work by executing code stored on the blockchain. This code contains the terms of an agreement between two or more parties and is designed to automatically execute the terms of the contract when certain conditions are met. For example, a loan smart contract can automatically release funds to a borrower if the borrower provides collateral that meets certain criteria.
Smart contracts are similar to traditional agreements, but have additional benefits of automation and security. Here's how they work:
Step 1. Agreement: two or more parties agree on the terms of a contract, just like in a traditional contract.
Step 2. Coding: the contract terms are written in code using a programming language specifically designed for smart contracts, such as Solidity for Ethereum.
Step 3. Deployment: the smart contract is implemented on a blockchain network, which enables all participants to access it.
Step 4. Execution: once the conditions of the contract are achieved, the contract will be automatically executed. This eliminates the need for intermediaries and decreases the probability of fraud or mischief.
Step 5. Transparency: smart contracts are characterized by transparency, which allows all parties to observe the code and execute it. This promotes trust and responsibility among the participants.
Step 6. Immutable: once built, smart contracts are unable to be altered or manipulated, this offers a high degree of security and prevents any accidental changes without the consent of the network participants. This ensures that contract terms are transparent, tamper-proof and enforceable without the need for intermediaries.
Smart contracts have several key features that make them attractive to both businesses and individuals.
Smart contracts don't involve legal professionals like attorneys or financial institutions to enforce the contract's terms. Instead, they utilize codes to automatically follow the rules and regulations listed in the contract. This eliminates the necessity of relying on third-party mediators.
All parties involved in a smart contract can access the contract's terms and the blockchain's record of execution. This guarantees that there are no ambiguity or misconceptions regarding the terms of the contract.
Smart contracts are cryptographed and maintained on a decentralized ledger, this makes them impervious to hackers or malice. This guarantees the terms of the contract and prevents unauthorized access.
Smart contracts automate procedures and reduce the time and expense associated with conventional contract execution. This increases its efficiency and effectiveness compared to traditional agreements.
Smart contracts have numerous practical applications in various fields.
Smart contracts can be used for lending, borrowing, insurance, and automated asset management. For example, a loan smart contract can automatically release funds to a borrower when certain conditions are met.
Want to learn more about how to lend and borrow crypto? Read this article where we uncover the process of lending/borrowing crypto assets.
Smart contracts can be used to track and verify goods in transit in real time. For example, a delivery smart contract can automatically issue payments to suppliers when goods are delivered to a buyer.
Smart contracts can be used to tokenize assets and automate rental agreements. For example, a smart contract for a rental property could automatically issue payments to the landlord when a tenant moves in.
Smart contracts can be used for royalty distribution and content management. For example, a music streaming service’s smart contract could automatically distribute royalties to artists based on the number of plays they receive.
Despite the numerous advantages of smart contracts, there are still some limitations and challenges that need to be addressed.
Smart contracts are still in the early stages of development, and current blockchain platforms may not be able to handle mass adoption.
Smart contracts may not be recognized under the current legal framework, making their enforceability in some jurisdictions uncertain.
Smart contracts may require accurate external information to satisfy their conditions, but in some cases it may be difficult to obtain.
Smart contracts are considered a groundbreaking combination of law and programming, they have the potential to revolutionize industries and simplify procedures. They have numerous benefits, including trust, transparency, security, and efficiency, all of which make them appealing to both companies and individuals. However, their flaws and limitations must be taken into account in order to make the adoption of them a reality. Future research, development and standardization is necessary to fully explore the transformative power of smart contracts.
