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What is a Smart Contract?

A smart contract is a line of code stored on a distributed ledger (blockchain) that automatically executes when pre-established terms and conditions are met. In other words, smart contracts are self-executing contracts with the terms of the agreement between buyer and seller being directly written into lines of code.

In simple terms, a smart contract is a program that runs as it has been set up to run by the developer who created it. The blockchain stores the contract code and its agreements.

Through the said distributed ledger, the code commands the execution, and transactions are trackable, transparent, and immutable.

These lines of code yield several benefits, most apparent in business environments and collaborations. In these scenarios, smart contracts execute and support certain types of an agreement to participants. These allow assurance of the outcome without the need for a central authority, legal system, or other external parties.

How did smart contracts begin?

Many people associate smart contracts with cryptocurrencies and, consequently, with the Ethereum platform. However, smart contracts were first proposed in 1994 by Nick Szabo. Surprisingly, the American computer scientist also invented a virtual currency named ‘Bit Gold’ in 1998, a decade before the invention of the popular Bitcoin.

According to BitDegree, Szabo is often reputed to be the person behind the unknown Satoshi Nakamoto, Bitcoin’s controversial inventor. As a matter of fact, Nick Szabo has denied the rumors.

Back in 1994, Szabo had the gleaming idea of being able to record contracts in the form of computing language. The cryptographer suggested that this contract would be activated in an automated way after assembling specific conditions.

As originally intended, it aims to avoid dealing with any third parties such as banks, by executing contracts through a trusted network totally controlled by computers.

Many may be wondering why the idea was not possible and accessible almost 3 decades ago when it was invented. The answer is simple: blockchain technology did not yet exist. But Szabo worked hard on this idea and even authored a book called “Smart Contracts: Building Blocks for Digital Free Markets,” published in 1996 and is being sold and used until today.

In 2009, in line with the public launch of Bitcoin, the first use of blockchain technology was unveiled. Six years later, in 2015, the young entrepreneur Vitalik Buterin came up with the Ethereum platform and finally began to introduce the first working smart contracts.

How do smart contracts work?

The famous consultancy company IBM stated that the simplest way to explain a smart contract is to compare it to a car purchase. The action of buying a car at a dealership implies several steps, a process that can become frustrating. Most of the buyers need to obtain financing to purchase a vehicle, or perhaps another expensive need such as a property.

When purchasing something without paying it outright, buyers might need a credit check and fill out multiple forms with personal information to verify their identity. Along this complicated process, buyers will have to interact with several different people called intermediaries. This phenomenon of needing multiple entities will make the process longer and more expensive, increasing the cost for a car purchase.

In association, what smart contracts on a blockchain can do is streamline this complex process, avoiding the lack of security and trust associated with the operations. With buyers’ identities stored into a blockchain, lenders can easily decide about the required credit. The process of validating the whole process becomes automated, quicker, and safer.

A smart contract would be generated between the various parties, including banks, dealers, and lenders, assuring the efficiency of the process. Blockchain records all transactions. This allows the automated transfer of ownership and distribution to participants. Any time, you can check this record.

Deployed smart contracts follow “if/when/then…” conditional statements. A network of computers (chain) performs all associated operations — from releasing funds to the appropriate parties to registering a property or even sending notifications. Meeting the predetermined conditions would enable the process. Moreover, each transaction will receive an update upon completion.

Therefore, smart contracts are also beneficial in a supply chain scenario by facilitating and validating the entire process. IBM explains the process in the following way:

Buyer X wants to buy something from Seller Y, so he puts money in an escrow account. Seller Y will use Shipper W to deliver the item to Buyer X. When Buyer X receives the product, Seller Y and Shipper W will avail the money in escrow. If Buyer X doesn’t receive the shipment by Date Z, the money in escrow will be returned. When this operation is executed, Manufacturer K is notified to create another of the items that was sold to increase supply. All are done automatically.

Through the use of a smart contract, buyers and sellers may complete requirements with satisfaction. It only depends on an interactive process that usually involves developers and business stakeholders, where they agree with predefined terms.

Multiple blockchain platforms including NEO and Ethereum create smart contracts. Among developers, Ethereum keeps being the most popular choice, that’s why it is so common to hear the term “Ethereum smart contracts” in the crypto industry.

What can smart contracts offer?

Smart contracts provide several benefits to transactions. These benefits go hand-in-hand with the blockchain. But what can they concretely offer?

Autonomy

Smart contracts eliminate the need for a third-party intermediary. It offers developers or business representatives the full control of their agreements.

Reliability

No involved party can steal or lose any part of the agreement when using smart contracts. Instead, pre-established rules are the basis of execution. Following this, participants can access the shared transaction records.

Saving Resources

With no need for intermediaries such as banks, advisors, or lawyers, smart contracts validate and verify all the procedures automatically, leading to fewer costs or fees.

Security

When implemented accurately, smart contracts are nearly impossible to hack. Blockchain’s cryptography automates and encrypts these lines of code.

Efficiency and Speed

Smart contracts involve complex and modern technology that optimizes its usage. People save a huge amount of time in terms of data processing, validation, and confirmation. It also avoids errors related to human factors since computer code is more accurate.

Global Use of Smart Contracts

Despite being consistently associated with cryptocurrencies, smart contracts and blockchain technology are more widely accepted in the stance of governments, financial regulators, and banks worldwide.

Several reputable institutions have adopted blockchain and smart contracts in their transactions. Included in the list are Google, Samsung, ING, and J.P. Morgan, one of the world’s largest banks. JPM has developed its own blockchain, named Quorum, using smart contracts to optimize internal bank operations.

In association with cryptocurrencies, the finance and banking landscape implements majority of smart contracts. Nonetheless, several other industries use it as a tool. For instance, governments worldwide can use this technology to make the voting system more accessible and transparent.

Supply chains can also utilize these contracts to monitor goods and automate payment tasks involved. Smart contracts can benefit other several industries, such as real estate by providing transparency on the process of buying and selling a property. To avoid tricky deals, developers make clear terms for each smart contract.

Healthcare has also a lot to benefit from this technology since the exchange of data between healthcare providers and patients is essential to create an efficient healthcare system, thus improving patient outcomes.

The Future of Smart Contracts

Smart contracts are already going mainstream. Several companies in the world already finalized operations through the use of these contracts to replace the middlemen.

It’s already happening, but what is the future for this technology? World leaders are increasingly showing their support for these simple code lines that optimize transactions and reduce costs. The jewelry giant, De Beers, for example, has already announced plans to launch the first industry-wide blockchain to track gems, verify authenticity, and ensure that they are not coming from any conflict zones.

In addition to solving financial problems, it resolves the lack of trust present in most transactions that involve too many intermediaries. However, there is a potential downside: people may lose their jobs.

For instance, smart contracts can replace traditional contracts. According to Piper Alderman,

Smart contracts have been dubbed as the technology which will bring an end to the legal profession as we know it.

The potential is enormous, but the future is not predictable. Smart contracts can effectively improve the business world, making us survive in a free-of-commission environment. They can also reduce fraud, delays, and high-operating costs. On the other hand, it is essential to consider that it may also decrease the need for specific jobs, which can be detrimental to the population.

If you are interested in seeing how smart contracts look like, ConsenSys presents examples like the following:

// badBank.withdraw(100); // Unclear whether trusted or untrusted

function makeWithdrawal(uint amount) { // Isn’t clear that this function is potentially unsafe
Bank.withdraw(amount);
}

// good
UntrustedBank.withdraw(100); // untrusted external call
TrustedBank.withdraw(100); // external but trusted bank contract maintained by XYZ Corp

function makeUntrustedWithdrawal(uint amount) {
UntrustedBank.withdraw(amount);
}


CoinQuora Staff

CoinQuora is an online publication that aims to educate about news, exchanges, and markets in the cryptocurrency and blockchain industry

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