Smart Contracts Explained

Smart Contracts Explained

Photo Courtesy: Melpomenem / iStock

The world’s economy has been revolutionized several times over the past 150 years. Ever since the industrial revolution, production methods have been improving at a faster and faster rate. With the introduction of computers starting in the 1960s, that rate only increased further as processing power and speed enabled businesses to achieve more. Then, with the introduction of the internet in the 1990s and its mass adoption starting in the 2000s, the economy transformed again, creating and expanding e-commerce to become the driving force behind financial, economic, and administrative activities.

The one thing we can draw from all these changes is that nothing is likely to sit still, and you never know when some new technology will take the economy to the next level. For that reason, many people speculate that smart contracts will have a significant impact by allowing individuals and corporations to remove “trust” from the equation when fulfilling financial obligations.

What Are Smart Contracts?

Technically speaking, smart contracts are decentralized applications that live on blockchains, allowing any user to fulfill the input requirements and receive the contract’s payout. Given the terms involved, it’s often difficult to grasp exactly what the contracts do and how they’re useful. To make it a little easier to understand, smart contracts are often explained using a metaphor about a vending machine or a self-checkout machine at a grocery store.

When you go to the store and pick out what you want, you’ll bring it to the self-checkout terminal. Because it’s just you and an automated machine, there’s no risk of a cashier making a mistake or stealing money from you. Instead, it just depends on you telling the machine what you’d like, and it will tell you how much you have to pay to get it. Once you’ve paid, you’ll get your receipt, and you can leave the store as the owner of whatever it is you bought.

Smart contracts work similarly. They’re designed to require specific inputs (for example, some amount of Ethereum tokens or ETH). Once someone has given that input, it will fulfill the contract by completing the associated action, such as putting a specific name on a title of ownership. Because this process is automated, there’s no need for any sort of middleman. Again, the smart contract is basically a program that says, “if X, then Y,” and you fill X and Y with whatever people want to trade or exchange.

What Makes Smart Contracts “Smart”?

The biggest difference between a regular contract and a smart contract is how they happen and are enforced. A regular contract requires two people or organizations to agree, sign the terms, and then promise to uphold those terms, as with an agreement to purchase a piece of rare art. Either the buyer will have to pay the money first, or the seller will have to hand over the painting first.

In either case, one trusts the other not to run away with the money or the painting. Therefore, there’s an element of trust or a need to get third parties, such as the government, involved using the threat of force (legal or physical) to enforce the contract.

A smart contract, on the other hand, is entirely automated and will fulfill the contract immediately after the correct inputs have been made. There’s never a moment where the buyer and seller need to trust each other. The smart contract is established to transfer ownership of the painting when the payment has been made, so the buyer sends the money to the smart contract rather than the seller. The contract then transfers ownership of the painting to the buyer without requiring any arbitration or other party. Because the smart contract’s code is clearly visible to all parties involved, there’s never any doubt about what will happen.

How Are Smart Contracts Useful?

Aside from streamlining contractual agreements, you can use smart contracts in numerous ways. More than a way to transfer property between two people, you can use them to share credentials and ensure both the security and uniqueness of information. This applies in exciting ways, such as providing forms of identification without requiring many layers of bureaucracy.

For just one quick example, smart contracts offer a theoretical way for people to vote in elections with much greater security than in-person voting and much greater convenience than mail-in ballots. The government could simply set up a smart contract that allows people to send digital vouchers that identify themselves uniquely and indicate for whom they’d like to vote without ever having to leave their homes. All these transactions are public to confirm the number of votes and who received them, while the identities of the voters themselves are more securely anonymized than they can possibly be in person.

Smart contracts are gaining more of a foothold in the business world, and the possibilities are endless. While people often think of cryptocurrency as a way to scam or get rich quickly, applications such as smart contracts reveal an untapped potential to revolutionize the economy yet again. As smart contracts continue to become more and more recognized, don’t be surprised if you start to see them brought up more on the news and eventually even in your own day-to-day life.