what is a smart contract and how does it work

What Is a Smart Contract and How Does it Work?

Smart contracts are the backbone of the blockchain ecosystem. Smart contracts assist in the exchange of property or currency in an efficient, effective and uncompromising way. These unique contracts help to facilitate transactions without requiring the need for an intermediary between the two transacting parties. Smart contracts are vital to the growth of the cryptocurrency world as we know it yet they still exist largely in the shadows. The truth is that most users have no idea that they exist nor the benefits that they offer. Today, you are going to be learning about smart contracts and the impact that they have had on cryptocurrency.

What Are Smart Contracts?

Smart contracts are most commonly used as part of the Bitcoin blockchain. Smart contracts operate as a self-auditing leger system that ensures that information being traded is incorruptible and authentic. In fact, without Bitcoin smart contracts the entire system would not be able to exist as it is today. Why is this the case?

Bitcoin rose to prominence because it offered users the ability to trade currency in a semi-anonymous and de-regulated way. There are no middlemen nor financial institutions seeking to grapple for control over Bitcoin’s many executed transactions. With that being said, nobody would use Bitcoin if they could not trust the transactions to go through and process as requested. It is hard to get two parties to trust one another, particularly in an anonymous space. That is where smart contracts blockchain technology comes into play.

A smart contract is a line of computer code that runs within the blockchain that cryptocurrency relies on. This line of numbers and characters is designed by a team of coders. The smart contract creates an agreement between both parties so that a specific set of rules are followed. Smart contracts help to make sure that all parties adhere to their agreement, thus allowing an anonymous transaction to be made with confidence. Smart contracts are intrinsic to digital goods and that is why the advent of blockchain contracts marks a monumental step forward for deregulated currency.

The term ‘smart contract’ is almost misleading due to the nature of the name. Smart contracts are not legal documents nor are they automatically going to be ‘smart’ irrespective of how they are implemented. In fact, smart contracts are only as effective as the team of coders behind their design. For this reason, it is important to keep in mind that smart contracts can be poorly designed, specifically if the team designing them doesn’t do their job. Smart contracts are not ironclad legal documents and they should not be treated or considered as such.

Key Benefits Of The Smart Contract

A smart contract has many uses and benefits when properly coded. Smart contracts typically help to accomplish a number of different tasks, including:

1) Formalizing An Agreement
2) Cutting Out Any ‘Middle Man’
3) Executing A Safe And Valid Transaction
4) Expediting The Process Of A Transaction
5) Ensuring The Accuracy Of A Transaction

Vitalik Buterin, the programmer behind Ethereum, explained the concept of smart contracts best while attending the DC Blockchain Summit. Buterin outlined the goal of a smart contract essentially in the following way:

A smart contract’s code is run overtop blockchain technology where it validates a specific ‘condition’. After validating the preset condition between the two parties, the code determines if the asset being traded (currency, property, etc) should go to the new owner or back to the original owner. While this is occurring, the self-auditing ledger system that runs the crypto world replicates information surrounding the trade. The documentation of the trade by the ledger system ensures that the smart contract is enforced and incorruptible.

While we tie smart contracts most closely to modern blockchain technology, they actually date back to 1994. Nick Szabo is a computer scientist who first proposed the concept of smart contracts well before the blockchain ‘rush’ that we are experiencing today. Szabo outlined the concept of a smart contract as such:

“A Smart Contract is a digital transaction protocol that seeks to execute a contract by following a preset list of conditions.”

Szabo designed the smart contract as an alternative to the traditional Point Of Sale (POS) system that is used by retail outlets throughout the world. Now, Szabo’s work has been appropriated throughout the blockchain world. From Bitcoin to the efficient Ethereum smart contract, Szabo’s work is being used to push digital transactions forward into the future.

What Can Smart Contracts Do?

While we most closely associate smart contracts with cryptocurrency, there are many applications that could benefit from them. Jerry Cuomo, the VP of blockchain technologies at IBM, is of the belief that the smart contract system can have a huge impact on a variety of important fields.

1) Government Systems – Cuomo argues that a smart contract system can be used in order to protect the voting system in America. Protecting votes by way of the ledger system could help to protect the integrity of the electoral system.

2) Retail Transactions – Jeff Grazik is the CEO of Bloq and he argues that a smart contract network can help to expedite retail production by addressing how supply chains operate.

3) Healthcare – Perhaps most importantly, smart contracts offer a way to revolutionize the healthcare system. By storing personal health records on the network, secured with a private key, a smart contract could help expedite healthcare management while enforcing current HIPAA laws.

The advent of the smart contract served as an important moment in the growth of blockchain technology. In only a short period of time, the smart contract system has helped to fundamentally change the nature of digital, anonymous agreements.