This article was written by Isonex Capital to explain what smart contracts are and how they function. In order to explain what a smart contract is and how they are employed, we should begin by explaining blockchain, which is the underlying platform on which smart contracts are written. Blockchain is a decentralized distributed ledger in which transactions between two users belonging to the same network are stored in a secure, verifiable and permanent way. All data related to the exchange are saved in cryptographic blocks. Each block represents a transactional record and the chains link them. The distributed computer network confirms the record and lists the blocks of transactions sequentially. It is this endless immutable chain of data blocks that make up the blockchain.
The foremost advantage of this design is the guaranteed high level of security. Once a transaction is certified and saved within one of the blocks, it is almost impossible to be modified or tampered with. Because the computers, or nodes, on a blockchain network are distributed, the mathematical puzzle and computing power required to make changes makes modification nearly impossible. To alter a chain, one would need to take control of more than 51% of the computers within the same distributed ledger and alter all of the transactional records within a very short space of time. To date, this has never happened. Your mission, should you choose to accept it … This tape will self-destruct in five seconds.
Each individual data block is connected to the previous block; this acts as a timestamp and can be traced and verified. One of the primary functions of the blockchain is to certify transactions made between parties. But this is only one of many possible use cases for this innovative technology. It can certify the exchange of shares, replacing the functions of a notary and validate a contact or secure online voting. In this way, businesses that employ smart contracts will rely only on themselves. The cost savings in external fees traditionally paid to outside organizations translates to higher profit margins. Cost savings aside, smart contracts also boost efficiency. When we consider what this could mean for charities, NGOs, the health services, and general bureaucracy, blockchain has the potential to impact efficiency and effectiveness throughout the developed world.
While governments, financial regulators and central banks have thus far been cautious in validating the legitimacy of cryptocurrencies, they have been far more open to the beneficial implications offered by blockchain and smart contracts. They are implementing this technology into their frameworks, because they cannot afford to be left behind. Blockchain is not only faster, cheaper and far more secure than traditional systems, it is also a futurist technology with no owner, no central server, no administrator and no national boundaries. It is at the forefront of discussions regarding the future of democracy, finance, legislation, personal information, health, security, insurance and more. Many are even discussing whether it could cause major disruption to traditional infrastructures. That, however, is the subject for another article.
Fraud reduction and recordkeeping — Smart contracts are kept in chronological order in a properly distributed blockchain network, wherein the outcome of such contracts is validated by everyone in that network, hence no one can publish and steal other people’s data.
In 1994 Nick Szabo, a legal scholar and cryptographer, realized that the decentralized ledger could be used for smart contracts. In this format, contracts could be converted to computer code, stored and replicated on the system and supervised by the network of computers that run the blockchain. This resulted in ledger feedback such as the transference of finances and receiving products and services. Smart contracts improve execution of the four basic contract objectives, which Szabo described as observability, verifiability, privity and enforceability. According to Szabo, smart contracts would enable both parties to observe the others performance of the contract, verify if and when a contract has been performed, guarantee that only the details necessary for completion of the contract are revealed to both parties and be self-enforcing to eliminate the time spent policing the contract.
So, in essence, a smart contract is a program containing a set of commitments, including how the contract participants shall fulfill these commitments. It executes across multiple computers so that the computers can have a consensus on the computation that enforces the validity of the contract. It is smart because it self executes once the conditions are met. It is crypto because it’s based on the principles of cryptography.
The benefits of smart contracts is that technologies like blockchain and cryptography ensure the execution of a peer to peer contract without needing to involve lawyers. Another benefit is that since smart contracts are implemented by computer code, there is no room for the ambiguous natural language often used in traditional contracts. Whilst it is uncertain if smart contracts will fully replace traditional contracts, they can lessen the burden and the complexity of writing a new contract each time, as the smart contract technology can be used to execute several terms of a contract between two parties automatically.
The use case most people are familiar with is the buying and selling or transfer of cryptocurrencies. A smart contract transfers the currency from one wallet to another and records the transaction on the blockchain. A smart contact works by two parties establishing terms of agreement of the contract. The contract is then developed and deployed on the blockchain, where specific actions are implemented within the contract. To initiate a transaction, an instance of the contract is created. Once all conditions are met, (for example, a sufficient amount is available), the contract executes settlement of the transaction and is added to the block. When a block is validated by miners, it is added to the blockchain. Transactions are recorded in a perpetual and immutable ledger.
Smart contract based platforms like Ethereum use smart contracts alongside blockchain technology, allowing anyone to create a trust-less smart contract for any purpose. One action commonly performed with the Ethereum blockchain is the launching of ICOs, specifically the pre-sale and the distribution of tokens. By using a smart contract, Ether can be collected and a new token distributed to cryptocurrency wallets across the globe, based on the terms of the contract. For those new to cryptocurrencies, it might feel questionable to hand an online company your Ether in the hope of receiving tokens back, if it were not for some assurance. The smart contract is that assurance. So as with cryptocurrency transactions, smart contract transactions leverage a technology that opens countless doors for trust-less peer to peer contracts.
In order to exist and function properly, smart contracts must operate within a specific suitable environment. The environment needs to support the use of public key cryptography, which enables users to sign off for the transaction using their unique, specially generated cryptographic codes. This is the exact system that the majority of currently existing cryptocurrencies is using. Secondly, they require an open and decentralized database, that all parties of the contract can fully trust and that is fully automated. Moreover the entire environment itself has to be decentralized for the smart contract to be implemented.
Today, smart contracts are a prototypical example of “Amara’s Law,” the concept articulated by Stanford University computer scientist Roy Amara that we tend to overestimate new technology in the short run and underestimate it in the long run. Although smart contracts will need to evolve before they are widely adopted for production use in complex commercial relationships, they have the impact to revolutionize the reward and incentive structure that shapes how parties contract in the future. It is important not to simply think how existing concepts and structures can be ported over to this new technology. Rather, the true revolution of smart contracts will come from entirely new paradigms that we have not yet envisioned.
The future of smart contracts — Harmonization through technology
Smart contracts hosts are constantly developing for greater interoperability. One such example is Stefan Thomas’s Codius. Codius hosts run code via hardware isolated virtual machines referred to as pods. This enables developers to develop code in any language they choose, then configure a pod on a Codius host with an environment that is able to run said code. The contracts run on independent hosts without an underlying blockchain, similar to traditional hosting. This allows them to interact with any service or API, scale infinitely and read from or write to any blockchain. The key challenge of smart contracts — interoperability — was solved. Developers can create apps that do not depend on or are more practical without a blockchain, granting them freedom to develop exactly the kind of app they wish to host. Through Codius, we are taking the first step towards providing infrastructure with built-in monetization.
The potential of smart contracts goes far beyond just facilitating transactions. Smart contracts can do anything you could imagine a software based contract doing, including interacting with decentralized applications. Smart contracts are not restricted to working in isolation, with many smart contracts working together to create a complex system. Smart contracts are more flexible than a traditional contract since they can essentially perform anything that software can. We have no doubt not yet fully realized the potential these technologies offer.
The benefits of taking one’s business into the digital era are wide-reaching, fraud prevention, cost reduction and immutability of the smart contracts are unquestionably huge. Smart contracts can be used in all spheres of our lives, from payment gateways to utility bills etc. This practically guarantees that smart contracts will be a foundation of the future global economy and a part of every citizens life.
Wired recently predicted that blockchain will rebuild the internet as we know it. One comment struck a chord: “Once blockchain technologies mature, they will recede into the background to become one of the fundamental systems powering the internet.” We are only at the beginning.
**Isonex Capital is dedicated to the growth of digital currencies within the global marketplace and in facilitating investment into the blockchain ecosystem. We strongly believe in investor protection through security and transparency. We are committed to helping newcomers gain an understanding of the risks involved in this new asset class. If you would like to find out more about us, visithttps://isonex.io