What are Smart Contracts?

What are Smart Contracts

Cryptocurrencies are developing so rapidly that it’s hard to keep up with all the innovations and ideas that appear. A decade ago almost no one believed that digital currency can co-exist or that they can compete with regular money. But since Bitcoin made the breakthrough a lot of things suddenly became possible. Like smart contracts and decentralized apps.

I’m sure that you’ve heard the term “smart contracts” at least once if keeping up with the news in the crypto world. But you might be wondering what smart contracts are and how they fit into the whole scheme. Then, you’ve come to the right place. Keep on reading to find answers to your questions.

#1 History of smart contracts

Can you imagine that the concept of “smart contract” was born more than 20 years ago? Might sound unbelievable, but it’s true. Have you heard of Nick Szabo?

Nick Szabo is a known cryptographer, computer scientist, and law scholar. His research into digital currencies and his creation of the “bit gold” (a digital cryptocurrency, which was never implemented) led many to believe that he is the person standing behind pseudonym Satoshi Nakamoto. That’s the founder of Bitcoin, whose identity remains a mystery.

Szabo’s “Smart Contracts” article was published in 1996 accurately predicting what would be accomplished later in the future. According to him “a smart contract is a set of promises in digital form, which you can store in a distributed ledger.” He wrote that it would be possible to design electronic e-commerce protocols and used them to establish business practices with strangers over the Internet.

#2 What are smart contracts?

A contract by definition is an agreement between two or more parties, which is enforced by law. For example, when you sell your house to someone you make agree that he gets the house, and you – the money.

Although smart contracts don’t have the same legal binding power as “real” contracts, they are still an agreement between people, which exists digitally, not on paper. Think about them as a computer program, which is “saved” on the blockchain. You can use them to exchange anything of value transparently without relying on a middleman. To explain it better, let’s give an example.

You’ve got a brilliant idea, but you don’t have the money to realize it. What would you do? You might ask the bank for a loan, but it might decide that your idea is too risky. Your next option could be Kickstarter.

You know about Kickstarter, right? The funding platform allows you to create a project, set a deadline and a goal. If you reach your goal –e.g., gather enough money from supporters, Kickstarter releases the money to you. If you don’t manage to collect the set amount of funds, the money goes back to your sponsors.

Here Kickstarter plays the role of the middleman. It’s an intermediary between you and the people who might be interested in your project. As such you have to place your trust in Kickstarter that it will handle things correctly and that you won’t remain empty-handed.

In simple words, you have to trust that you’ll get your money if you reach your goal. Your supporters also have to trust Kickstarter that their money will go to your projects or that they will get them back in case of failure.

Smart contracts eliminate the need to trust a third-party to handle your money, so you don’t need anyone to serve as a connection to your business partner. You set the terms under which you’ll get the funds, for example gathering $10, 000. Then you start collecting money from supporters, who would send them to the smart contract.

If you reach your goal, you automatically get the funds. If the opposite happens, your supporters received them back. Neither you nor your sponsors will wonder when and how you’ll get the funds.

It’s simple and straightforward concept, which will make cheating so much harder because everything is distributed on the blockchain. After smart contracts gain popularly and earn the trust of the majority, you won’t need platforms like Kickstarter anymore to fund your projects.

#3 What are the benefits of smart contracts?

Some of you might be asking, “Why should I make a smart contract instead of a regular one?” Well, here are the main advantages of smart contracts:

#3.1 Lack of intermediary

As I said, we eliminate the need to place our trust in third parties. It means that you’re the one making the agreement and setting the terms. There is no need for a layer or a broker, which is great. You know that legal advice is not cheap, so you’ll be saving money from all fees. What’s more, since the terms are automatically executed no one can influence the process or delay it.

#3.2 Immutable

Once you create a contract, it’s immutable. In simple words, it means that no one can change the terms because all the nodes have copies. So you don’t have to worry about your partner going behind your back and cheating you or that you won’t receive your money when you reach your goal.

#3.3 Distribution

Another advantage of the distributed smart contracts is that everyone validates the output. What it means is that not a single person can force the release of the funds. If someone attempts to do it, the rest of the nodes will see it and won’t validate the contract.

#3.4 Back-up

Sometimes banks or layers can lose your valuable documents, which can be very inconvenient. If you choose smart contracts, you don’t have to worry about it. As we said, the smart contracts are distributed on the blockchain, which means that there are a lot of copies available. If by any chance something happens to yours, you know where to find another one.

#3.5 Safety

Since smart contracts are a stored on the blockchain, they are encrypted with cryptography. Hackers will find it very hard to penetrate the defenses. It’s almost impossible to change the terms of the contract because they would have to make the change in all copies of the contract kept by the nodes.

#3.6 Time-saving

Usually, you need a lot of time to fill a lot of paperwork to make a legal agreement with somebody. Not to mention that you might have to go through several institutions. Now, thanks to smart contrasts, you don’t have to wait for someone to process the documents manually. What’s more, since they are written in code, the potential for a human error is much lower.

#4 Where can you process smart contracts?

Currently, there are a couple of blockchains, which supports smart contracts. Although Bitcoin is one of them, it has a limited ability to process them. Instead, Ethereum is the one specially designed to implement smart contracts using a special programming language called Solidity. To create such contract, you’ll have to spend some of the native coins of the blockchain – Ether.

You can also create smart contracts on NXT or Cardano, or you can use the side chains that run adjacent to Bitcoin.

#5 What are the possible applications of smart contracts?

Smart contracts can be useful not only for crowdfunding projects. They can have their place into:

#5.1 Government

Smart contracts may be used to create a more secure voting system, which would be impossible to hack due to the inherent traits of the blockchain.

#5.2 Business

Since smart contracts are less time consuming than regular documents, we can see how they can cut the amount of workflow and improve its accuracy and transparency. Banks could also implement them for automatic payments or for issuing loans. They can also be used by insurance agencies to process claims.

#5.3 Healthcare

If you’re worried that someone is going to see your healthcare records, the implementation of smart contracts will make that impossible. Once the records are stored on the blockchain, they could be accessed by people with a specific key and no one else.

#6 What are the potential problems with smart contracts?

As you see, smart contracts seem like an excellent idea. However, there are a couple of problems that have to be resolved:

  • ​How would the government tax such contracts? By law, you have to pay taxes for every penny you received as payment.
  • ​Who would regulate these contracts? What happens when the two parties are from different jurisdictions?
  • ​What happens if there is a mistake in the code? For smart contracts to work the code must be written perfectly, and if you make a mistake, it might be impossible to fix it.
  • If you change your mind what would you do? Remember that the contracts are immutable.

We can conclude that smart contracts have a bright future ahead of them as part of the developing cryptocurrency community. They have immense potential, which if harnessed properly, will change how business works and allow you to trade with other people without an intermediary.

Did you understand what smart contracts are? What do you think about them? Are you willing to try it out? Tell us your thoughts in the comments and share the article with your friends.

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