Smart Contracts were first proposed in 1994 by Nick Szabo, a computer scientist and legal scholar. They are designed to be self-executing contracts over the blockchain platform. They are also referred as blockchain contacts and digital contracts.
What are Smart Contracts?
The Blockchain serves as a decentralized ledger that keeps the integrity of the information for the designated purpose. Smart contracts are pieces of code that live on the blockchain.These programmed contracts are executed automatically when the conditions are met. They can be used to exchange anything of value including money, property, shares. The advantages of the blockchain – decentralized, faster, cheaper, and more secure, serve well for smart contracts too.
The Ethereum project tried to improve upon the Bitcoin. It introduced the idea of decoupling the contract layer from the blockchain layer. Thus, the ledger itself is now used by smart contracts. Transactions get automatically executed when certain pre-defined conditions are met.
Soon blockchains like NEO also started to incorporate smart contracts into their blockchain. The aim is to provide a more flexible development environment for decentralized applications.
How Smart Contracts work?
The smart contracts have the properties of contractual agreements. They are directly written into lines of code and directed onto the blockchain. They mostly take place between buyer and seller. Money paid for product or services offered.
Various clauses and sub-clauses define the possible scenarios. They can: 1. Perform calculations, 2. Store information and 3. Send transactions to other accounts.
Note that smart contracts are not equivalent to legal contracts.
Example of a standard token contract.
Firstly, the individuals involved will define the purpose. They would then write down the contract conditions as a code. The contract is finalized and deployed on the blockchain.
Now, when a particular condition of the contract is met, the contract is triggered. The contract executes according to the programmed rules. Contracts generally have expiration rules. They are useful when the condition of the contract are not met within some period of time. The information on the contract and encrypted, this allows for some privacy. The individuals participating in the contract can also protect their privacy by the use of public and private keys.
Digital contracts offer a great way for the efficient execution of contractual terms. As they are self-executable, they offer immense value. They can be used for all sort of things ranging from financial derivatives to insurance premiums, crowdfunding agreements etc.
A video explainer
Smart contracts aim to remove the need for the middleman to help oversee the agreements. They make it possible to have transactions that are traceable, transparent, and irreversible. Decentralized applications (dApps) are possible only because of these digital contracts.
Although contracs on the blockchain are quite useful, bugs in the code can cause issues. Moreover, not all agreements or all the aspects of the agreement can be met through these digital contracts. The ‘legality’ of these digital contracts also needs to be addressed. The future of this new technological functionality matures as it tries to overcome significant challenges it faces.