Want to know more about smart contracts? In this blog we define and explain what a smart contract is, and how it is used.
A Simple Definition For Smart Contracts
Smart contracts are digital contracts stored on a blockchain that are automatically executed when certain conditions are met. They can be developed for everything from financial transactions to supply chain management, while taking advantage of blockchain’s security, reliability and worldwide accessibility.
How Do Smart Contracts Work?
Smart contracts are written as code on the blockchain, following basic “if/when … then” instructions. It could be anything as simple as sending a text notification when an account falls to a certain level of funds, emailing tickets to a show purchased online or even used to facilitate an election and count the votes. When the transaction is completed, the blockchain is updated and cannot be changed, forever leaving a permanent record that only parties with permission can see. Smart contracts are traceable, transparent and irreversible.
Benefits Of Smart Contracts
Speed and efficiency – when a condition is met, a contract is executed immediately. There is no further consideration given or red tape that exists in the real world.
Trust and transparency – without the involvement of third parties and because encrypted records are shared across participants, there are no concerns about whether any records have been manipulated.
Cost effective – the absence of third parties, including lawyers, also acts as a significant money saver by eliminating associated fees.
Security – blockchain’s security mechanisms mean smart contracts can be enacted with confidence. Encryption makes them difficult to hack and impossible to achieve without leaving telltale evidence.
Environmentally friendly – with all transactions being digital, there is no paper trail.Definitive – the terms and conditions of a smart contract are executed to the letter. There are no grey areas and no room for interpretation.
Limitations Of Smart Contracts
Inflexibility – By design, a smart contract cannot consider circumstances such as real world events that have influenced an outcome and are not written into its code. This can be problematic in the event of a legal challenge. Many traditional contracts include terms like “good faith” or “reasonable” to provide flexibility.
Legal ramifications – Because of their inflexibility, it is critical that both parties who enter into a smart contract are aware of the ramifications of public, private, criminal and mercantile law.
Delayed transactions – This can be caused by heavy traffic on the blockchain, occasionally resulting in the attraction of higher fees than would have resulted from a traditional contract.
Potential Applications For Smart Contracts
The potential applications for smart contracts are many and varied but they are ideally suited to sets of circumstances which are black or white.
Financial transactions – smart contracts are tailor made for DeFi (decentralized finance) and its vast array of applications.
Supply chain management – they allow businesses and consumers to track the movement and quality controls on goods around the world to their door. A cut of beef for instance can be traced from farm to fork.
Healthcare – improves efficiency, shares health records with appropriate providers and reduces waiting times.
Real estate – a trusted payment platform for sales, recurring rentals or using real estate NFTs as collateral for loans.
Business and corporate governance – increases government, bureaucratic transparency and accountability, while reducing expenditure of public money.
Insurance – using travel insurance as an example, a smart contract will automatically and instantly pay out if a flight is missed or delayed longer than an agreed time.
Entertainment – ensuring artists are paid fees and royalties owed as well as protecting copyrights and preventing piracy and fraud.
Publishing – cutting out the middlemen or agents between publishers and artists or writers, leaving more money for all while safeguarding the integrity of artists’ work.
A Real World Example Where We Needed Smart Contracts
Republicans have long cried foul over the results of the 2020 US Presidential election. If the election was conducted via smart contracts on the blockchain, there could be no such discussion. Centralized voting systems will always be susceptible to miscounts, enrollment fraud, multiple voting or corruption of voting officials. Using a smart contract, none of this is possible and the result of an election is trusted as pure. Every vote is recorded on the ledger, cannot be modified and is publicly visible for audit and verification.
The History Of Smart Contracts
Cryptographer Nick Szabo first proposed the idea of smart contracts in a paper in 1995 that was published the following year. Szabo envisioned them as similar to vending machines and saw them as “a set of promises agreed to in a meeting of the minds [which] is the traditional way to formalize a relationship”. The arrival of Bitcoin in 2008 accelerated the arrival of smart contracts before the launch of Ethereum in 2015 which uses them as a fundamental tool of the platform.
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