A smart contract can simply be defined as a computer code that runs on top of the blockchain. It contains a set of rules that determine how the involved parties can interact with each other. So, whenever these predefined rules are met, automatically the agreement is enforced. It’s the purest form of decentralized automation.
The smart contract code is responsible for facilitating, verifying, and enforcing the negotiation or performance of a transaction or an agreement.
The idea of smart contracts was initially conceived in 1993 by Nick Szabo a cryptographer and computer scientist. He described them as a kind of digital vending machines. At the time he gave an example that explained how users could input value or data and in turn receive a finite item from a machine like a soft drink or a snack.
Interestingly, the term smart contract is quite unfortunate since these codes are neither intelligent nor should they be confused with legal agreements. It’s important to note that a smart contract can only be as smart as the people that code it. Also, they have the potential to become legal contracts in case certain conditions are met. However, they shouldn’t be confused with legal contracts that are accepted by law enforcement or courts.
But, with the area fast developing we are starting to see a fusion of smart contracts and legal contracts.
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Characteristics of Smart Contracts
Smart contracts offer numerous advantages, for example, they are capable of tracking performance in real time consequently bringing tremendous cost savings. Also, compliance and controlling can happen on the fly. To get external information a smart contract will use the help of information oracles that will feed it with external data. So simply put smart contracts are;
- Tamper resistant
They can also;
- Lower the cost of transactions
- Guarantee more security
- Reduce the reliance that is placed on trusted intermediaries
- Help turn legal obligations into automated processes
The Smart Contract Process
- Pre-defining the contract.
- Here the terms of engagement are established by all counterparties, e.g. currency to be used to make payments, the currency rates, and variable interest rate.
- The conditions for execution are also set; for example the time, date and even the variable interest rate at a given value.
- Events – here events trigger the implementation of the contract.
The events can refer to; the information received and initiation of the transaction.
- Execution and the transfer of value – here the terms of the contract will dictate the movement of value which is based on if the conditions have been met.
- Settlement of the contact – this can happen in two ways;
- On chain assets (digital)– in the case of virtual assets such as cryptocurrency, the accounts are automatically settled.
- Off-chain assets (physical) – for assets like stocks and fiat, the changes to accounts on the ledger will match the off-chain settlement instructions.
Benefits Of Smart Contracts
Smart contracts allow for the terms and conditions of these contracts to be fully accessible and visible to all the relevant parties. Once the agreement has been established, there is no way to dispute it.
One of the main requirements of smart contracts is the need to record all the terms and conditions in precise details. The element is necessary since an omission can result in transaction errors. So, automated contracts try to avoid the pitfalls that are associated with manually filling out heaps of forms.
Smart contracts employ the highest level of data encryption that is currently available, the same as what is used by cryptocurrencies. By doing this, their level of protection is among the best and the most secure on the world wide web.
Smart contracts live on the internet and run on software code. As a result, they can execute transactions very fast. This speed can save many hours when compared to traditional business processes.
This is the byproduct of accuracy and speed. The great thing is that higher efficiencies lead to more value generating transactions which are processed per unit of time.
- Clear Communication
When setting up smart contracts, there is a need to detail everything accurately. This means there is no room for miscommunication or misinterpretation. Therefore, they can cut down on efficiency that is lost to gaps in communication.
- Storage and Backup
Smart contracts are used to record vital details of each transaction. Therefore, wherever an individual’s details are used in a contract, they are permanently stored for future reference. So, in case there is data loss then these attributes can be easily retrieved.
The good thing about smart contacts is that they inspire absolute confidence in their execution. The secure, autonomous and transparent nature of these agreements takes away the possibility of bias, manipulation or error.
- Guaranteed Outcomes
This is another attractive feature of automated contracts. They have the potential to significantly reduce or even eliminate the need for litigation and going to courts. By employing self-executing contracts, these parties commit themselves to operate by the rules of the underlying code.
One of the primary benefits of a smart contract is that they eliminate the need for having a vast chain of middlemen. This means there is no need for lawyers, banks, witnesses and any other intermediaries.
Types of Smart Contracts
Smart contracts have the potential to disrupt many industries including the banking sector, insurance, telecommunication, art world, music and film, education and many more. They range from simple to complex.
An example of simple contracts includes time stamping services like ascribe for art registry — also, governmental and semi-governmental records for land titles, birth certificates, school, and university degrees.
However, many regulatory aspects are made up of complex contracts. A good example is the Decentralized Autonomous Organization which represents the most complex form of smart contracts.
Examples of Simple Contracts
- A simple digital value exchange – let’s imagine an employer sending some Bitcoins to an employee.
- A smart right and obligation contract – let’s imagine a consumer that buys a digital content stream.
Examples of Complex Contracts
- Distributed autonomous government – let’s imagine settlers of a previously uninhabited area who code their own self-enforcing government services.
- Distributed autonomous organization – let’s imagine self-driving trucks that make P2P deliveries and pay for local toll road fees.