Smart Contracts, Explained

What is a smart contract?

A smart contract is a protocol for regulating contracts.

A smart contract is a special protocol intended to contribute, verify or implement the negotiation or performance of the contract. Smart contracts allow to perform credible transactions without third parties. These transactions are trackable and irreversible. Smart contracts contain all the information about the contract terms and execute all envisaged actions automatically.

How did smart contracts appear?

The idea was originally described by computer scientist and cryptographer Nick Szabo in 1994.

He defined the main principles of work, but at the time there was no appropriate environment to realize them. A lot has changed since Blockchain technology emerged. Bitcoin laid the basis for contracting on the Blockchain. However, its tools couldn't meet all needs. The appearance of Ethereum put smart contracts into operation for everyone, giving further impetus to dealmaking.

How do smart contracts work?

The main principle can be compared to the work of vending machines.

They execute only the instructions given to them automatically.

At first, assets and contract terms are coded and put into the block of a Blockchain. This contract is distributed and copied multiple times between the nodes of the platform. After the trigger happens, the contract is performed in accordance with the contract terms. The program checks the implementation of the commitments automatically.

What do I need to create a smart contract?

To create a smart contract you need:

  • Subject of the contract

The program must have access to goods or services under contract to lock and unlock them automatically.

  • Digital signatures

All the participants initiate an agreement by signing the contract with their private keys.

  • Contract terms

Terms of a smart contract take the form of an exact sequence of operations. All participants must sign these terms.

  • Decentralized platform

The smart contract is deployed to the Blockchain of this platform and distributed among the nodes of the platform.

Where can smart contracts be used in real life?

Smart contracts can apply to different fields.

  • Elections

Voting results will be put in the Blockchain and distributed among the nodes of the network. All the data is encrypted and anonymous. This method eliminates any possibility of manipulation with the ballot.

  • Logistics

The supply chain is generally long and includes a lot of links. Each link has to get a confirmation from the previous one, hold up its end of the contract and send the information further. It takes a lot of time and is unproductive, while with a smart contract each participant can see the progress and do the work in time. Smart contracts ensure transparency in the contract terms, fraud protection. It can also provide shipments tracking with the integration of the Internet of Things.

There are some other possible applications, i.e. in management, bank system, insurance, estate, IoT, and others.

What are the benefits of smart contacts?

Smart contracts use all the benefits of Blockchain technology.

Smart contracts provide:

  • Security

The smart contract is encrypted and distributed among nodes. This guarantees that it will not be lost or changed without your permission.

  • Economy and speed

Most processes are automated, and most intermediaries are eliminated.

  • Standardization

There is a wide range of different types of smart contracts nowadays. You can choose one and change it according to your needs.

What are the cons smart contracts have?

Smart contracts are not that perfect, after all.

Here are some of the issues smart contracts might have:

  • Human factor

The code is written by people, and they can make mistakes. If the smart contract is in the Blockchain, it couldn’t be changed. A good example of the human error is The DAO. Developers’ mistakes in the code were costly for the users and the company - some hackers exploited errors and stole about $60 mln.

  • Uncertain legal status

Currently, smart contracts are not regulated by any government. So there is a potential issue if governmental institutions decide to make a legislative framework for smart contracts.

  • Implementation costs

Smart contracts cannot be performed without programming. It is essential to have an experienced coder on the staff to make fail-proof smart contracts and adopt the internal structure of the company for Blockchain technology.