A simple explanation of smart contracts: what they are, how they work, and how they might affect us all
Blockchain technology is transforming how we interact in this ever-evolving digital world. The technology offers digital currencies and contracts without the need for banks or other intermediaries, and the industry is constantly welcoming top tier talent within tech, finance, and programming to work on furthering it.
Even Steve Wozniak, co-founder of Apple, couldn’t resist joining the industry, announcing that he partnered with a crypto-asset focused fund just earlier this week.
Anyone learning about Bitcoin, Ethereum, and/or wider blockchain tech, might have heard of smart contracts.
Now, the questions you may have been to embarrassed to ask:
- What are smart contracts?
- What is their history?
- What is their application and potential effects?
Here’s what you need to know about smart contracts and how cryptocurrencies use them for improved contract agreement efficiencies.
Ethereum and the Birth of Smart Contracts
In 1996, computer scientist and cryptographer, Nick Szabo, birthed the idea of a smart contract. He believed the digital revolution was radically changing the relationships we can have, and that it paved the way for new institutions and new ways to formalize the relationships that made up those institutions.
Szabo wanted to create a contract that was a “set of promises, specified in digital form, including protocols within which the parties perform on these promises,” while calling out the old ways as “inanimate paper-based ancestors”.
Nick Szabo was, at the time, already seeing immense potential for the new digital age.
It wasn’t until 2015 that his vision of smart contracts came alive with the launch of the Ethereum blockchain.
Since its launch, Ethereum has become the second biggest blockchain in the world, known for its developers’ vision of where the digital age should head towards. Just like the ideas of Nick Szabo, Ethereum was specifically designed and created, principally by Vitalik Buterin, for one reason: smart contracts.
What is a Smart Contract?
- Smart contracts are decentralized, computerized contracts that include a complex set of rules embedded in code — or to simplify — are a promise made by two parties in the form of a digital contract, completely cutting out the middle man, that ensures that all pre-decided promises are met before distributing what the contract entails.
- A smart contract allows you to trust in a contract rather than a third-party; in code rather than (a) human(s). The most beloved analogy for smart contracts, is the vending machine — as seen on just about every article on the subject. You’re thirsty, and decide to walk over to the nice vending machine sitting near your office. You put your crisp dollar bill into the machine, and out pops a soda. If your dollar spits back out at you, you get no soda. Once you hold up your end of the deal with a dollar, the machine then holds up their end of the deal and gives you a soda. This is, essentially, how a smart contract works.
- Because the actual contract itself is a computer protocol that can be verified, signed, and deployed to a blockchain, there is no need for a third-party to initiate the agreement as it can be established person-to-person, and enforced automatically.
Just some of the applications of the technology include using it for collateralizing items/assets of value, blockchain-based mortgages, decentralized financial networks, referral/reward platforms, health monitoring apparel, spend management systems, and much more.
With third-party traditional contracts that are used by banks, brokers, governments, in real estate transactions and more, a third-party would outline the contract terms and draft the document. With smart contracts, they can be developed personally, or via an ease-of-use platform — like Block66’s mortgage platform, specifically for mortgages — and can be deployed and signed in a digital, secure and transparent manner, by all participating parties.
There are two key traits to smart contracts that make them worthwhile; they are immutable and distributed. Because they are on the blockchain, the code is near impossible to tamper with. Once the smart contract is created, it cannot be changed, and because the output is validated by everyone on the network, no single person can force changes to the contract because others will spot the attempt and mark it as invalid. It allows both parties to place their trust in a contract that will meet every expectation promised.
The Buzz Around Smart Contracts
From developers to financial institutions and law firms: interest in smart contracts is growing. Some of the interest surrounding smart contracts, is based on whether they will replace lawyers and other professionals for certain functions, and potentially threaten jobs due to removing the need for a third-party intermediary for certain transactions.
While the contracts themselves are encoded, complex agreements, it may take a long time before smart contracts are used in legislature and courts alongside traditional legal agreements, for applicable purposes.
For now though, they are appealing to realtors and anyone that wants to bypass a third-party payment to a lawyer or law firm, and for those that are building blockchain-based decentralized applications, or ‘dApps’ — which constitute an entirely different use of the technology, and is deserving of its own article, which is why I’m not going into extreme detail here.
Saving time and money on legal agreements is a compelling reason to use smart contracts, but one concern is based in how the code is set up, and are focused on the question of what will happen if the two parties want to make changes to what will be an irrevocable set of instructions.
When a contract isn’t set up properly, or when/if the two parties wish to change the terms, this proves more challenging with smart contracts where code is irrevocable. Richard Howlett with Selachii LLP suggests to alleviate this, developers might want to ensure the initial code includes alterations that can help with foreseeable incremental changes that might need to occur. While the execution of obligations between the two parties will still take place, if there’s any disparity regarding the terms or clauses in the contract, with the proposed alterations, the legal wrapper would take priority if a conflict of interest arises, or a failsafe could be employed.
Smart Contract Legal Benefits
Georgetown Law Technology Review found smart contracts to be innovative legal agreements. A self-help approach that can outline a legal contract between two parties, smart contracts may one day be used in courts alongside traditional legal agreements. When using smart contracts, information can not be tampered with or cheated. They are also time-saving because they don’t require third-parties such as a lawyer or bank to draft the contracts and verify them, making them more fluid while also being cost-effective as they require no payment fees to third-parties.
Ensuring accuracy and autonomy, smart contracts aren’t exacted by hand, and can be set up between two parties without waiting for a third-party verification. That means they are cheaper because a smart contract will only require a cryptocurrency payment to set up, and can be set up by anyone.
Because smart contracts provide the highest level of safety for all data that is included, they reduce the incidence of fraud or manipulation. In a digital world that’s offering more transparency and data safety, smart contracts are time-saving, cost-reducing, and represent ingenious digital solutions for transactions. Though they may not replace lawyers yet, they can start eating away at their market-share already.