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Smart contracts are blockchain-based digital agreements that have the power to:
1. auto-execute without being triggered by the agree-ers and
2. directly transfer funds from one party to another.
Many consider smart contracts to be a powerful tool that might transform even our day to day agreements with other people. Smart contracts are run on blockchain platforms, the most prominient of which is Ethereum.
Smart contract (noun): An agreement coded onto a blockchain which has the ability to 1. automatically execute upon 2. completion of specified terms and 3. transfer funds from one party to another.
Don’t worry, we know it’s a mouthful of rather vague terms. Let’s unpack:
- Smart contracts are coded onto a blockchain. That is to say, instead of writing an agreement on pen and paper, you can write an agreement in code, sign it digitally, and upload it to the blockchain where your code is run by a network of computers. Once pushed to the blockchain, the contract cannot be altered by the people involved in the agreement.
- Smart contracts can “automatically execute.” When the terms of an agreement are met, no one person must trigger completion of the contract. The blockchain will know the outcome of the agreement and complete the contract without anyone telling it to do so.
- Smart contracts have the ability to transfer funds between parties.
These three things make smart contracts akin to agreements with superpowers, to quote Henning Diedrich in his book, Ethereum. Smart contracts are decidedly different, and more efficient, than traditional pen and paper contracts.
Using a paper contract involves uncertainty, risk, and hassle. It is always possible that you, or the person you enter an agreement with, do not abide by the contract. For instance, the person supposed to pay you could refuse to. Handling these kinds of conflicts in our current legal system is both costly and slow.
Smart contracts do away with the need to enforce an outcome (in the legal sense). The code of a smart contract includes the power to transfer money from one party to another, so when the terms of an agreement are met the contract automatically completes payment. Think of it like a digital contract, but with an escrow service built in.
This makes the contract “trustless,” meaning that the contract does not require trust to be involved at all. With a pen and paper contract, you are forced to trust that the other party will fulfil their terms. When using a smart contract, you do not have to trust anyone. No one has to agree to pay you at the end of the contract, only in the beginning, when they first sign.
Right now, there are many platforms that host smart contracts. The largest is Ethereum, whose cryptocurrency (more accurately, cryptocommodity), called Ether, is the second largest by market capitalization behind Bitcoin. The Ethereum platform hosts smart contracts primarily written in Ethereum’s own coding language, Solidity. Another platform is the NEO blockchain, which is based out of China.
Smart contracts do have limitations, and they have yet to become widely accepted. Regardless of the word contract, it is unclear whether a smart contract will stand up as a legal document in court. Another possible issue is that smart contracts are permanent the second they are deployed to the blockchain. What if there is a problem with the underlying code that’s only identified after the fact?
It is likely that we will see many advancements in the usability and implementation of smart contracts in the coming months and years. Much of this progress is already underway.
Example Use Case
Adding to the utility of smart contracts is their ability to act on information stored outside of the blockchain. This works because we can feed information to a smart contract. A program that pushes information to the blockchain is called an “oracle.” Yes, it’s really called that. Yes, it does sound cool.
Let’s say you and I make a bet about the outcome of a sporting event. You bet me .1 Ether (the native currency of Ethereum) that in an upcoming match, the Decentralogs (D) will beat the Blockspitters (B). Since I think the Blockspitters are a better team, I take the bet. You and I have a few options in terms of writing out an agreement.
We could take out a piece of paper and write down “If B beats D, you pay me .1 Ether, and if D beats B, I will pay you .1 Ether.” One would hope that upon seeing the final score of the match, we would complete the bet by one of us paying the other, but contracts don’t always work as anticipated. Perhaps I think there was an unfair call during the game, and refuse to pay.
What to do! Let’s review your options:
- Forget about the bet entirely (you’d be out some Ether! Not good!).
- Sue me for the lost funds. Unfortunately, in reality you’d likely end up paying far more in legal fees for this to be worth suing over (not to mention the hassle). In this case, a pen-and-paper contract is extremely difficult to enforce if you or I decide not to follow through with our agreement.
On the other hand, we could use a smart contract. We’d write the exact same terms (using a coding language), digitally sign, and deploy the contract to the blockchain. Upon deployment, you and I have to pay a small fee for the contract to run. This fee is far lower than what would normally be charged by an escrow service.
The contract would include an oracle, which would automatically feed the contract the result of the game.
For better or worse, regardless of unfair calls or wanting to get out of the bet, at the end of the game the contract will execute on all computers associated with the blockchain and one of us will receive payment. Once we sign the contract, the agreement is totally out of our hands. No need to enforce. No delayed payments or arguing. No legal fees of any kind.
This is just one example of how smart contracts may replace traditional ones. Some argue that smart contracts will influence a multitude of industries because they have the potential to operate more efficiently and cheaply than paper contracts, and do not require trust between parties.
Imagine a future world with a future economy. Driverless, flying cars whirring about. Automated hot dog stands. Comical and science-fictiony as they may be, these are both cases that could make use of smart contracts.
Think about it! Any time you sign a contract or enter an agreement is a potential opportunity to utilize a smart contract. Think mortgage payments, supermarket purchases, or payroll doled out by a company.
The first industries to be affected might be law, banking, insurance, and escrow services. Law firms might have to adapt to a world where both signed papers and digitally signed code are treated as legal documents. Banking will adapt to using smart contracts for completion of all sorts of payments. Insurance systems might be entirely run using smart contracts and Internet connected devices (known as the Internet of Things, or IoT). Escrow services might be phased out entirely by less expensive, more efficient alternatives.
We can’t know how exactly how smart contracts will be integrated into our society, but their implementation is likely to further democratize our economy and make our existing systems more efficient. Keep an eye out!