What are Smart Contracts?

What is a smart contract? Smart contracts are self-executing contracts or sets of instructions written in code to facilitate transactions between two parties (usually a buyer and seller).

Nick Szabo, a computer scientist, law scholar, and cryptographer proposed the idea of smart contracts in 1994. By his definition, smart contracts are computerized transaction protocols that execute terms of a contract. In particular, he also proposed the execution of a contract for assets such as derivatives and bonds. Szabo’s concept became reality when Ethereum was launched on July 30, 2015, allowing anyone to write contracts as code and store them on a blockchain.

Using Smart Contracts on the Blockchain

Because smart contracts are coded, automated, and decentralized, this enables transactions to run quicker, cheaper and most importantly with a low error and default rate compared to human-administered contracts.

A smart contract uses the blockchain to store code in its database. If the conditions in the code are fulfilled, the smart contract will then execute the instructions that were coded into it. For example, you could write a smart contract that would automatically send 100 USDT from Wallet A to Wallet B if NFT C was delivered to Wallet D by writing a piece of code such as “IF <Wallet D> contains <NFT C>… THEN transfer <100USDT> from <Wallet A> to <Wallet B>”.

Characteristics of Smart Contracts

The purpose of Smart Contracts is to reduce overhead costs, verify transactions and execute transactions without the need of a third party. Smart Contracts usually have several characteristics:

  • Self-Executing when the contract’s conditions or requirements are met;
  • Tamper-Proof because no one can change what’s been programmed on the blockchain;
  • Self-Enforcing because they are autonomous and automated.

Smart Contracts in Our Lives

A simple example of a “smart contract” would be a vending machine. When you put money into the machine and press a button for a drink you will receive the drink and if there’s change, it will be automatically dispensed back to you. This shows that the drink vending “contract” is self-enforcing because when you put your money in, it dispenses a drink for you without further human intervention.

On top of that, you can also select the drink that you want and if you pay the right amount, you will receive the correct drink. This is all programmed onto a printed circuit board – code in the form of hardware. The code and the contract is executed by a mechanical device in the machine.

Compare this example to buying a drink from the convenience store. There might be a chance that you get the wrong change, or the cashier keyed in the wrong item which can lead to inventory issues. Or perhaps the cashier is on lunch break or sick, which would seriously impede your ability to complete the transaction.

Vending machines have revolutionized retail and distribution, and has become an industry in its own right. When vending machines were first introduced, they were purely mechanical and worked by mechanically measuring the weight of a coin. Then in the computer age, printed circuitboards became the norm. The blockchain is building the next generation of “vending machines”.

Advantages of Smart Contracts

Because smart contracts remove the involvement of a 3rd party, this ultimately creates an environment where two entities can perform any deal like the exchange of money, property, shares or other things with value based on the rules or codes written in the smart contract itself.

And because the terms and conditions of the smart contract are transparent, visible and accessible to the trusted parties, it will prevent disputes once the contract has been written down in code.

Industries that benefit from Smart Contracts

The potential application of Smart Contracts can be utilised in quite a few industries.

The most obvious benefit is in the financial industry. Financial transactions already utilize manual contracts to govern loans, rates, exchanges, and payments. Numerous financial products are by nature contracts, such as futures, swaps, options, and contracts for difference. Eliminating the need for humans to press buttons or do other administrative and mechanical processes will reduce costs and errors, and the chances of default or fraud can be nearly eliminated if the code is well-written.

In the healthcare industry, smart contracts can allow patients to enable caregivers to gain access to their electronic-Health Records (eHR). Electronic health records are easier to access compared to the traditional method of keeping paper backed copies but the weakness of electronic records is security. But with eHR, care givers can access the patient’s information once access is granted by the patient, and the patient’s privacy is protected by blockchain technology.

Smart Contracts can also be used in logistics as well as merchandising. When the shipment or goods arrive at a destination, the smart contract can be set to release invoices, delivery orders and manage approvals once all signatures are collected.

The future of Smart Contracts

As blockchain technology continues to develop, the growing use of smart contracts will also transform the way we operate businesses or deal between parties. Smart contracts form the basis for DeFi, or decentralized finance, which is the provision of financial services without the need for a centralized governing party.

As smart contract platforms like Ethereum continue to add to the capabilities of blockchain technology, we will see smart contracts filling in the roles formerly performed by lawyers and administrative workers. And as more things in our lives take on a digital form (digital money, digital tagging, digital assets, NFTs, digital identity), smart contracts will have an ever-growing field of applications.

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