What are smart contracts?

You must have had the opportunity to deal with time-consuming, bureaucratic aspects of signing contracts, whether it’s buying a car, starting a new job or something else. Blockchain technology has the potential to make this process incomparably faster and more reliable.

Instead of going to the notary or lawyer to whom you have to pay for the service, and then wait for the document to be created and signed, you can use a computer system that is based on if-then logic, and your bond or the license will be automatically sent to you. Not only that; besides defining the rules and penalties in case of a breach of terms, smart contracts automatically execute the obligations defined. But how?

Just as digital currencies allow performing transactions without the need for an intermediator (e.g. banks), smart contracts allow concluding agreements between two or more parties without the need for a guarantee from the central legislative authority. These new types of contracts are characterized by a high level of trust and transparency, much more than traditional contracts.

Famous computer scientist and cryptographer Nick Szabo, known as one of the key figures of blockchain technology and digital currencies, realized back in 1994 that a decentralized ledger (synonym for blockchain) can be used to execute digital contracts. Szabo proposed the implementation of computerized protocols that automatically enforce the terms of the contract. Contracts are converted into code and copied to the entire computer system on the network (contracting parties). In this way, an automated execution of contractual obligations, such as transfer of money, or providing services and using products, is enabled.

In addition to creating the concept of smart contracts, Nick Szabo also designed a mechanism for the first decentralized cryptocurrency — ten years before the arrival of bitcoin! For this reason, many believe that he’s actually Satoshi Nakamoto, an anonymous creator of bitcoin (even his initials are identical), but he categorically denied it.

Examples of smart contracts can be seen in the two most popular digital currencies, bitcoin and ethereum. Transactions using bitcoin can be executed online (validated by other nodes) only if predefined conditions are met. Unlike the most well-known cryptocurrency that is limited to monetary use, ethereum is expanded with a programming language that allows developers to write new instructions (programs, ie. smart contracts).

The concept of smart contracts can be illustrated on the basis of three characteristics:

• The agreement between the contracting parties is recorded on the blockchain network. The contracting parties may be anonymous if they want to, but the smart contract is available to everyone on the public ledger.
• An event, such as the beginning of insurance period or some product’s expiration date, triggers the execution of a smart contract in accordance with the terms written on the blockchain.
• Legislators, state authorities and other institutions have the ability to monitor the execution of the contract, respecting the privacy of the parties involved.

It should also be noted that smart contracts can only be executed if the required percentage of the contracting parties agrees with it (for example, 51% of the signatories). They can also serve as a database or library of other contracts, as well as to store much other information, such as a list of members of an organization.

Smart contracts are also a necessary element of the increasingly popular way of crowdfunding using cryptocurrencies, called Initial Coin Offering (ICO). For example, when a startup company defines the amount it wants to collect for its project, the money will be returned to all investors if the amount is not collected by the specified date.

Now, when you have a clearer picture about smart contracts, imagine the ways they can be applied (and already have been). Not only that the voting results for the parliament can’t be disputed, but they can also be monitored in real time, even allowing you to change your vote before the official end of voting. In the automotive industry, the cause of the accident can be recorded on the blockchain network, which makes it easy to determine whose fault it was — a human factor, factory error or something else. Musicians also look forward to smart contracts; fans can pay for downloaded songs directly to them, without commission from the record company.

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