What Are Smart Contracts?
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What Are Smart Contracts?
What Are Smart Contracts?

What Are Smart Contracts?

A novel concept, introduced by cryptographer and legal scholar Nick Szabo in 1994, and later further developed by Ethereum co-creator Vitalik Buterin—among other notable figures—both intrigue and  provide a glimpse into the near future, with the potential to benefit and permeate many, if not all, sectors of our society. But how exactly do smart contracts work, and how can they be realistically implemented?

How do smart contracts work?

A smart contract can be defined as a program, application or computer protocol running on a blockchain. The objective of the protocol is to verify and execute the negotiation of the contract. By blockchain definition, this means it runs on a trustless manner, which makes it possible that two different parties come to an agreement without trusting (or even knowing) each other. If any one of the conditions of the agreement fails to be met, by either one or multiple parties, then the contract cannot be executed.

Obviously the application of such technology has massive potential to reduce operational costs and the need for a central authority or other third parties acting as intermediaries. Open source, decentralized blockchain technology also enables smart contracts to be created by just about anyone around the world, a feature known as “permissionless”.

Both top current cryptocurrencies in terms of capitalization and popularity, slightly differ in their approach and implementation though. Bitcoin features a Turing-incomplete language, allowing the creation of smart contracts only on top of Bitcoin, via a sidechain for example. In the case of Ethereum, the platform is Turing-complete, which means it provides a robust, on-chain framework, without the need of another layer built on top of it.

A simple example of a smart contract would be an ERC20 token (launched on the Ethereum network) for a new song or hit single, giving its creator the ability to receive royalties globally and directly from streaming, downloads and even licensing, with no third party required.

Are smart contracts safe?

As with any other technology, it is made—in this case, written—by humans, so logically the room for error not only exists, it is to be expected. While everyone can create a simple smart contract with even basic understanding of code and following online tutorials, they are meant to be written (and later audited if possible) by professional and experienced developers only, as in most cases high financial value is involved one way or another.

The most infamous example of a smart contract failure is the DAO hack back in 2016. Immutability (another feature of smart contracts) proved to be a huge hindrance in this case, with the only option to fix the issue being a rollback of Ethereum blockchain which resulted in a hard fork, even if the issue wasn’t on the Ethereum blockchain itself but in a bug inside the main smart contract itself.

Examples of smart contracts

Although the application of smart contracts can permeate and improve almost all current applications in our society, they are particularly best suited for certain sectors.

Supply Chain

Another simple example that illustrates the need for smart contracts is the logistics industry. The ability to track a package in real time, in a very precise and transparent manner cannot be overstated. Smart contracts can not only help reduce costs significantly, they may also help make transportation of goods (from food to medicine) much safer and secure.

Finance

Our financial structure and monetary system has a lot of problems so it’s not surprising that this a sector primed for disruption. From decentralized loans, security tokens and scrow like services to IoT (Internet of Things), mortgages and traditional insurance, where both parties could easily enter an agreement without the need of a lawyer or other intermediaries.

Tokenizing entire industries—like real estate for example—will create new, highly liquid markets. Any investor can now own a fraction of a commercial building and earn monthly rent directly into his/her wallet.

Digital Identity, Government and State Level

From medical and personal records to intellectual property, the potential here is endless. On the Government level, both national identification and passport issuance alone would bring tremendous benefits, along with transparency and security improvements to current voting and electoral systems. Land and real estate ownership could also be made globally verifiable by anyone with an internet connection, preventing fraud and/or unlawful expropriation.

All these combined may be able to finally bring true data ownership to all global citizens and end users for the future of blockchain