Explaining Smart Contracts To an 11-Year Old
When do you refer something as ‘Smart?’
Let’s take the most well-known example — A Smartphone.
So, how ‘Smart’ is a smartphone? Why is a phone called a ‘Smartphone?’
Well! You certainly know that your smartphone doesn’t make calls for you. In that case, you would have called it an ‘Intelligent phone.’
A smartphone process information ‘Smartly’ for you whenever you require it. How it manipulates the information in a particular way depends on the instructions (stored in the form of a code) given by the specific application. Thus, it is the applications present in your smartphone, which processes the information in the desired manner, that makes your smartphone ‘Smart.’
What exactly is a ‘Contract?’
A contract, in the simplest terms is an agreement between two entities (individuals or organizations), that specify a certain action (mutually agreed upon) to be taken if a certain event occurs.
If A happens — do B.
If A not happens — do C.
Take the example of David and Sam who entered into a contract for business. According to the contract, in the event of occurrence of loss, David and Sam would share the loss amount in the ratio 40:60. However, in the event of occurrence of profit, the profit would be shared in the ratio 50:50.
Okay, now what is a ‘Smart Contract?’
If we combine the understanding of ‘Smart’ and ‘Contract,’ we will get very close to understanding what a Smart Contract is.
Like an application in a smartphone which contains instructions to process information, ‘Smart Contracts’ contains instructions (in the form of a code) to process ‘Contracts’ (conditional actions). They are self-executing codes written to get automatically executed when exposed to a certain data inputs which act as triggers.
If coded that way, on getting exposed to a trigger (data input), Smart Contracts can result in ledger updates. Well, you do know that Blockchain works on the concept of Distributed Ledger, in which every node (computer) in the network has a copy of ledger, which gets updated every time a new transaction happens!
Execution of Smart Contracts can lead to updates in this shared ledger, which can be for transfer of assets including digital money.
Let’s see how this will happen in real life scenarios.
Smart Contract - Pay the insured $100 if the flight gets delayed
Data Trigger - Flight Data
Smart Contract - If the patient walks more than 5 Km in a day, pay him five tokens (tokens can be exchanged for various health services)
Data Trigger — Data from the wearable device of the patient
Smart Contract — Pay the artist $1 every time his songs get played
Data Trigger — Artist’s songs get streamed online
These are just a few examples out of the hundreds of real world uses cases of Smart Contracts. Compared to an ordinary contract, Smart Contracts once formed are unalterable. They are bound to get executed if exposed to the right trigger. Since they don’t need to trust each other, participating parties who might not know each other can enter into a Smart Contract. The Smart Contract will get executed autonomously as per the mutually agreed condition written in its code.
Another feature of Smart Contracts is that they can communicate and interact with each other. They can be used in combination, i.e. the outcome of a Smart Contract can be a trigger for another Smart Contract.
Let’s us understand this with an example.
A medicine is supposed to be stored at a temperature lower than 2°C while transported from manufacturing factory to the distributor.
Smart Contract A — Send alert to medicine manufacturer if the temperature rises above 2°C.
Data Trigger — Data from the sensors (internet enabled) stored with the medicine.
Smart Contract B — Mark the consignment as ‘Cancelled’ and record the details of the cold chain responsible.
Data Trigger — Alerts generated from Smart Contract A.
In the above example, due to the execution of two Smart Contracts, there will be alerts send to the manufacturer as well as consignment will be marked ‘cancelled,’ holding the cold chain transporting the medicine responsible.
However, there can be other triggers for the execution of Smart Contract B as well, due to which it may mark a consignment as ‘cancelled,’ for example, delay in delivery.
Hey, this looks similar to the process by which those Credit Card payments get deducted automatically from my Bank Account!
In the most basic sense, you are right! It is somewhat similar to automated banking, the phenomenon because of which the EMIs get automatically debited from your accounts balance. But it is different in a lot many ways.
The first and most important difference is control.
I believe if you are reading this blog then you must be knowing that Smart Contracts are something related to Blockchain. Well, if you know about the Blockchain, then it’s great, if not then it is a story I will tell you some other day. But in the Smart Contract context, it is important for you to know that one of the main features of Blockchain is the removal of the Central ‘Controlling’ Authority.
The processes of automated banking are controlled and verified by the central authority i.e. The Bank. This is not the case with Smart Contracts which are a part of distributed ledger system of a Blockchain in which every transaction is verified by multiple parties in the system.
Also, the code is present on this decentralized network of the Blockchain and not a single computer, as in the case of automated banking, which means more transparency and security.
So this means Blockchain Smart Contracts can replace Legal Agreements?
The answer to this is ‘Yes’ and ‘No.’
Yes, because Smart Contracts doesn’t behave in unexpected ways. In the traditional agreement, lawyers can use legal terms to manipulate the interpreted outcomes of the agreement, which is not the case with Smart Contracts.
Traditional Agreements have two essential elements.
1. Actionable: It describes the actions as agreed, which would be taken by both parties in the occurrence of an event. This part is exactly what is included in the Smart Contract.
2. Non-Actionable: These are references to other documents and jurisdiction implications. In short, this is something which interests ‘lawyers’ and as such holds no importance till the things go wrong. This is not included in the Smart Contract. However, the references can be added as comments in the code.
By this time you must have understood that the reason people want to use Smart Contracts is that they don’t trust each other. They want to automate the process of execution of obligations arising out of an agreement.
Utilizing Smart Contracts, people and firms can also protect themselves from the ‘legal riddles’ deployed by lawyers, or from the mutual misunderstanding of the agreed initial trade terms not specifically mentioned in the contract. They eliminate the mismatch happening because of the different versions of the copies of the agreement. (since there are a lot of exchanges involved before the final agreement copy is made)
And ‘No,’ because the conflict management remains pretty much the same. You need to follow the same old traditional ways via courts. However, in the case of Smart Contracts, the transfer of value would have already taken place. That’s why you should be all the more careful of what goes into the Smart Contract.
Are they really Autonomous?
Smart Contracts are autonomous, but they can’t operate in isolation. They don’t act on their own. They require some specific stimuli (a data trigger) to get executed.
Ethereum Blockchain was designed for the purpose of building and executing Smart Contracts. They are used extensively for the execution of complex conditional tasks and even for the very simple task of issuing token in exchange for money.
If they are so awesome, why they are still not being utilized extensively!
There can be two reasons for this:
First, not every Blockchain supports Smart Contracts, and the ones which do may not support them like Ethereum. As discussed above, Ethereum was made for developing and executing Ethereum Smart Contracts, but it is a Public Blockchain. (A Public Blockchain can be joined by anyone while a Private Blockchain can be joined by authenticated users only). Storing something confidential on a ‘Public’ platform, no matter how secure & transparent it is, will always have a risk factor associated with it.
Secondly, the code of the Smart Contract is far from being ‘Perfect.’ In the recent DAO attack (Decentralized Autonomous Organization — A complex Smart Contract that was made on Ethereum Blockchain to allow companies to make proposals for funding) the hacker was able to force the DAO Smart Contract to give ‘Ether’ before it was able to execute ledger updates. (Ether is the internal digital currency of the Ethereum Blockchain)
What lies in the future for Smart Contracts…
The journey of any new technology starts from initial buggy phase and later it gets globally accepted if it can overcome that buggy phase and move ahead. Same is true for Blockchain Technology too.
About Smart Contracts specifically, their applications in the real world scenarios are so many that one way or another they would be utilized to streamline processes. The latest example is the Government of Sweden which has already started using Smart Contracts for Land Registration. Dubai is all set to become the first Blockchain economy where Smart Contracts would be deployed extensively to automate processes.
It would be right to assume that in the future, Blockchain and Smart Contracts would influence every business and individual around the globe.
About the Author: Mohd. Anas Rasheed is a Blockchain Enthusiast and has been researching and writing on Blockchain Technology from almost a year.
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Originally published at medium.com on August 30, 2017.