What is a Smart Contract?
|— Contracts are an important part of our everyday lives. But they’re slow, inefficient, and costly to enforce.|
— Thanks to blockchain, we now have ‘smart’ alternatives known as smart contracts—which may be poised to disrupt almost every industry there is.
— They’re faster, cheaper, and more flexible than traditional contracts, and can be used to automate practically anything.
— But they’re still somewhat experimental and their full capabilities are still being explored.
What is smart contract? how does it differ from a normal contract? and what are its use cases? we’ve got the answers.
Right now, if you want to get anything substantial done, odds are you are going to need a contract.
This is a legally binding agreement that can pertain to practically anything, such as the transfer of property, general employment contracts, non-disclosure agreements, licensing contracts, and more.
They make for dense, boring reading, but they’re an important part of the financial world and there’s really no getting around them if we want to transact safely.
But the way we form and deal with contracts is beginning to change thanks to the invention of a new type of self-executing digital contract known simply as a ‘smart contract’.
The problem with contracts
Contracts are typically a written document describing who does what, under which conditions, and when. In the case of a dispute, the terms of the contract are usually used to resolve it through an arbitrator or mediator, but in some cases, the court of law may need to get involved to settle matters.
Although contracts are so prevalent in today’s society, they almost all suffer from the same set of issues; they’re slow to create, difficult to enforce, and often subjective—some are even written to be deliberately vague or misleading… how annoying!
If there’s an issue with a contract, getting it resolved can be an absolute nightmare.
It can take weeks, months, or potentially even years to see the result of a dispute—which is not only incredibly inconvenient but also expensive.
Given that it can cost potentially thousands of dollars to settle a dispute this way, this makes it uneconomical to enforce contracts for low value arrangements.
What’s the point of a contract if it can’t be easily enforced?
Contracts typically require the involvement of third parties to be enforceable.
After all, if you’ve got a contract to buy a house at an agreed price, then the seller backtracks on the agreement, you’ve got to follow through the proper legal channels to get it resolved—likely paying intermediaries in the process.
There’s usually no simple way to resolve contract disputes mano a mano as they say. And that just won’t do.
Though it doesn’t happen often, contracts can be forged, modified, or destroyed—all of which are extraordinarily impractical or difficult to detect.
When there are no copies, this effectively renders the contract useless, and there have been cases where people have forged contracts and gotten away with it—at least temporarily.
All in all, they’ve got a whole bunch of limitations, but change is on the horizon!
The smart solution
If contracts designed to make our lives easier? Why are they so difficult to enforce? Surely there is a better way…
Well, it turns out there just might be. They’re called smart contracts and they’re disrupting not only the financial world, but practically every industry under the sun.
In their simplest form, smart contracts are snippets of code that are used to automatically execute an agreed-upon set of terms.
Just like a regular contract, a smart contract is used to ensure everybody involved in an agreement knows exactly what is expected of them, and is used for ensuring all parties fulfill their obligations.
So, how do smart contracts work?
As we touched on earlier, smart contracts are basically self-enforcing contracts—they don’t need any intermediaries to get involved to ensure an agreement is carried out.
But how do they actually go about doing this? Well, it’s down to the way they’re built. Smart contracts contain code that is automatically executed by the blockchain network itself—whatever is written in the code will be carried out once triggered.
This trigger might be a user telling the smart contract what to do through a decentralized application (Dapp) or simply when a specific event is detected; such as a price change, a new president gets elected, or even if it starts raining in a particular place—or anything else the contract is programmed to react to.
For example, you might use a smart contract to automatically send $50 worth of cryptocurrency to a family member when it’s their birthday. The payment function would be triggered when their birthday is detected (e.g. via a trusted data provider like an oracle), with no manual input needed from you or anyone else.
Being built on top of incredibly secure decentralized networks like Ethereum, smart contracts have several unique properties that make them particularly promising.
For one, they’re tamper-proof. This means once a smart contract has been created, it’s pretty much impossible to alter it without leaving an obvious trail.
They’re also not open to interpretation. No technical jargon to wade through, no secret clauses, and addendums to content with. In the case of smart contracts, code is law. Whatever is written out in the contract will be carried out— no ifs, ands, or buts!
Away with the middleman
As their name suggests, these contracts are ‘smart’, which in this case means they don’t require any intermediaries to carry out their functions.
This is an incredibly cost-and-time efficient way to get things done. After all, middlemen and other intermediaries are often costly, time-consuming, and can add lengthy delays when it comes to resolving disputes.
All this is a thing of the past with smart contracts, since there’s nothing up for interpretation and nothing to dispute.
Right now, if you want to enter into a contract with somebody, odds are you’re going to need to fork over some private information to do so—providing your identity and address details (and perhaps more).
But with smart contracts, this generally isn’t needed. It’s entirely possible to anonymously enter into contracts, while still benefiting from the same level of security. This is because they’re trustless—you don’t need to trust the other person since the smart contract will automatically
Overall, smart contracts offer an entirely new layer of confidentiality, while also ensuring your private data cannot be sold, misused, or mishandled!
In the early days of the crypto industry, smart contracts were mostly used for games of chance like Roulette, since these are (relatively) easy to create and allowed users to wager their cryptocurrencies without needing to trust that the casino is necessarily fair (see: provably fair).
Since then, developers have used smart contracts for a huge number of useful, creative, and even wacky purposes, producing some incredible examples of how this simple technology can be used to disrupt today’s industries.
Nowadays, smart contracts have been applied to practically every industry; and have been used for securing land ownership records in Africa; boosting the efficiency and transparency of supply chains; blockchain-based voting; and distributing royalty rewards.
There’s even a smart contract that allows you access to your cryptocurrency tokens for a fixed duration, ensuring you don’t sell or spend them too early and miss out on any potential price appreciation.
If only we knew about this five years ago!
Besides solving some of the main frictions of existing industries, smart contracts are also powering an entirely new range of industries that were simply not possible with conventional contracts.
One of these industries is known as ‘decentralized finance’, or ‘DeFi’, which is essentially an entire ecosystem of decentralized financial services — like trading platforms, interest-bearing accounts, stablecoins, and insurance protocols.
Ever heard of stablecoins, decentralized exchanges, or yield farms? Yep, all examples of DeFi!
Most of these DeFi platforms are accessed through a decentralized application (dApp) which makes interacting with the underlying smart contracts a more intuitive task — much like how your favorite food delivery app lets you order Pizza without needing to interact with any of the underlying code.
To find out more about how DeFi is revolutionizing finance, check out our short overview of the subject: here.
Are smart contracts the future?
Smart contracts aren’t a new concept, in fact, the idea of a self-executing digital contract has been around for more than two decades, and was first mentioned in the 1990s by a man many call the father of smart contracts—renowned computer scientist Nick Szabo.
But it was only recently that the technology for truly capable and secure smart contracts has existed—blockchain technology. Nowadays, there’s a bunch of different blockchains that support smart contracts.
Right now, they’re still very much in their early days of development and adoption, and still suffer from some growing pains that still make them relatively niche—such as potentially high fees and user experience limitations.
Today, just a small fraction of the population interacts with smart contracts regularly—most of which are cryptocurrency users.
But that might soon be about to change. With more efficient blockchains being developed and massive firms now developing their own smart contract-capable blockchains, like IBM’s Hyperledger Fabric and R3’s Corda platform, smart contracts are becoming increasingly mainstream.
With enterprise-friendly smart contract platforms now growing in adoption, it might not be long before smart contracts move from being the technology of the future, to the technology of today.
Knowledge is power – so keep on learning! If you enjoy getting to grips with crypto and blockchain, check out our School of Block video Smart Contracts for Beginners.