Smart contracts can be defined as a computer protocol designed to enforce credible performance or execution of a contract between different parties. Terms and conditions of an agreement between a buyer and a seller are encoded on a distributed decentralized blockchain network.
This self-executing code (triggered by involved parties) enables virtual exchange of anything without the need of a middleman.
A good demonstration of a smart contract is the vending machine. If you want a snack from a vending machine you must first drop in some money, then your preferred snack pops out.
Smart contracts act like vending machines; they work on the If-Then premise. If you drop 10 dollars, you get a soda otherwise you get none. There need not be a shopkeeper nearby to enforce this.
The real events of a smart contract follow this process. An asset or currency is transferred into a program. The smart contract runs automatically. It validates the condition and determines where the asset should go depending on whether the condition has been met or not.
In case the condition is not met, the sender can be refunded instantly. Meanwhile the distributed ledger stores these transactions giving them security and immutability.
Smart contracts were first defined by Nick Szabo, an American cryptographer in 1998 as computerized transaction protocols that execute the terms of a contract. The idea came from trying to extend the functionality of electronic transaction methods to the digital domain.
However, Vitalik Buterin, become the most significant promoter of smart contracts when he founded Ethereum, an open-source blockchain that uses smart contracts to expand its capabilities and enable developers to create applications on it. Ethereum is thus considered the next generation blockchain after the numerous improvements it made on Bitcoin blockchain.
What are the benefits of Smart Contracts?
- Self-governance. They provide autonomy since you don’t need brokers to confirm. Besides, manipulation from third parties is impossible because the network manages the contracts; no single party has more computing power than the entire network.
- Security of documents. Smart contract function within a blockchain which incorporates cryptography to encrypt data. The decentralized nature of the network and immutability of recorded data makes it impossible to hack.
- Trust. Upon execution, smart contracts generate documents which are stored and replicated across the entire decentralized network producing unchangeable records; full trust.
- Time-saving. As compared to manual processes involving middlemen and brokers, smart contracts are infinitely faster. For instance, DTCC processed 345 million securities transactions in 2015 through smart contract distributed ledger technology.
- Backup. With thousands or even millions of nodes each maintaining a copy of the ledger, there is no way the data can be lost.
- Accuracy. Besides being fast, smart contracts eliminate human errors made during the processing of contracts like filling heaps of forms. They are automated and have no room for errors unless badly coded.
- Cost-effective. With the elimination of intermediaries and brokers, the cost of processes is greatly reduced with automated computer protocols
Potential Applications of Smart contracts.
Smart contracts don’t only work in the financial realm, they can potentially be applied in many other sectors and industries.
- Healthcare. To protect the privacy of patients, smart contracts can be programmed to store medical records and assign private keys which enable access to specific individuals.
- Land Ownership. A distributed ledger of transactions can be developed and encoded with smart contracts that enable the provision of tokenized title deeds which are transferable based on land purchase and sale transaction.
- Elections. Voting systems can be built on blockchain technology and encoded with smart contracts which eliminate the need for voters to line up, show identity and complete forms. Instead, voting is moved onto a secure platform on the internet and voters can exercise their democratic rights from anywhere.
- Supply Chain Management. A business can use smart contract powered supply chains to improve its inventory tracking due to full visibility and transparency. Also, a secure and accessible digital version of management systems can be provided to all parties and automate tasks and payments.
These are just a few of the many use cases for smart contracts and blockchain technology. Indeed, the work, costs and time that can be saved using smart contracts is enough to send entire industries on a different path.