The Capital
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The Capital

Are Smart Contracts Really That Smart?

By CoinJoy on The Capital

One of the most important elements of any transaction is trust. Each of the two parties involved in the conclusion of the agreement must be sure that the other party will fulfill its part of the contract. However, legal documents that ensure the security of transactions require examination and supervision of their compliance. The use of smart contracts will help to cope without intermediaries and facilitate the exchange of assets.

Smart Contract History

The principle of smart contracts was described by American cryptographer and programmer Nick Szabo in 1996 long before the development of blockchain technology. According to the concept of Szabo, smart contracts are digital protocols for transmitting information that use mathematical algorithms to automatically complete a transaction after meeting specified conditions and complete process control. This definition, which was way ahead of its time by more than ten years, remains accurate up to this day. However, in 1996 this concept could not be realized: at that time the necessary technologies did not exist, in particular, a distributed database.

In 2008, the first cryptocurrency — Bitcoin — appeared, its creation was based on revolutionary blockchain technology, which previously lacked a decentralized database. Bitcoin’s blockchain does not allow setting conditions for a transaction in a new block since it contains only information about the transaction itself. Nevertheless, the development of technology served as an impetus for the development of smart contracts. Five years later, the Ethereum blockchain platform allowed the usage of smart contracts in practice. Today, plenty of platforms allow using smart contracts, but Ethereum remains one of the most popular.

How do smart contracts work?

Smart contracts are computer protocols or, more simply, a computer code that is accepted by all the parties.

Obligations of the parties are provided in a smart contract in the form of “if-then” (for example: “if Party A transfers money, then Party B transfers the rights to the apartment”). There can be two or more participants, and they can be individuals or businesses. Once these conditions are met, the smart contract independently performs the transaction and ensures that the agreement is followed.

Smart contracts allow exchanging money, goods, real estate, securities, and other assets. The contract is stored and repeated in a decentralized database, in which information cannot be falsified or deleted. At the same time, data encryption ensures the anonymity of the parties to the contract. A crucial feature of smart contracts is that they can only work with assets located in their digital ecosystem. The combination of the virtual and real worlds is considered one of the main difficulties in working with smart contracts. This is the reason why “oracles” exist — special programs that help computer protocols to obtain the necessary information from the real world.

Benefits of Smart Contracts

  • Speed. Manual processing of documents takes plenty of time and delays the execution of tasks. Smart contracts propose an automated process and in most cases do not require personal participation, which saves time.
  • Independence. Smart contracts exclude the possibility of third-party interference. No need to look for a specialist to close a deal.
  • Reliability. The data recorded in the blockchain cannot be changed or canceled. If one party does not fulfill its obligations, the other side will be protected by the terms of the smart contract. No need to manually fill out many forms with the risk of making mistakes.
  • Saving. No need to pay for intermediaries.

Disadvantages of Smart Contracts

Despite their huge potential, smart contracts also have their drawbacks:

  • Lack of regulation. There are no concepts of “blockchain,” “smart contract” and “cryptocurrencies” in the worldwide legal field.
  • The complexity of implementation. Integrating smart contracts with physical elements often takes a lot of time, money, and effort.
  • The impossibility of changing the smart contract. Ironically, one of the main advantages of smart contracts can also be regarded as a conflict. If the parties reach a better agreement or new factors arise, they will not be able to modify the contract. Most likely the options for additional agreements should be implemented as new blockchain platforms are developed.

Where can smart contracts be used?

Smart contracts can change different areas worldwide. We can distinguish several industries in which smart contracts will be used most effectively:

  • Finance
  • Insurance
  • Electronic commerce
  • Audit and taxation
  • Elections

Individual contracts, of course, will not disappear, and legal guidance will always be required to prepare them, but it will now be coupled with the development of smart contracts that save time, open up new areas for clients, and create positive shifts in the market.

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