We have talked about smart contracts before. However, it is something that deserves its own article. To start off, what are smart contracts? Smart contracts are a little computer program that stores contracts.
Once all requirements are met, the contract completes itself. Once it does this, the transaction or agreement is posted to a public ledger and cannot be changed or altered. Now the main reason that they are exciting is that they are efficient and secure. They cut the need for a trusted third part and lower the cost.
“It’s worth noting that bitcoin was the first to support basic smart contracts in the sense that the network can transfer value from one person to another. The network of nodes will only validate transactions if certain conditions are met. But, bitcoin is limited to the currency use case. By contrast, ethereum replaces bitcoin’s more restrictive language (a scripting language of a hundred or so scripts) and replaces it with a language that allows developers to write their own programs. Ethereum allows developers to program their own smart contracts, or ‘autonomous agents’, as the ethereum white paper calls them. The language is ‘Turing-complete,’ meaning it supports a broader set of computational instructions.” - Coindesk
Ethereum is the favorite among many who are designing or working with smart contracts. It is flexible and has plans to move away from just mining as a way of enhancing its applicability. “Ethereum has plans to move away from mining altogether by changing the consensus algorithm from Proof-of-Work (PoW) to Proof-of-Stake (PoS). PoS creates blocks based on the token holdings of the nodes rather than computational power. In addition, Ethereum plans to tackle scalability by implementing “sharding.” Sharding breaks up the blockchain into many many interconnected sub-blockchains. Bitcoin currently has no such plans.” -Solomon Lederer, Blockchain: A Practical Guide to Developing Business, Law, and Technology Solutions
Now how exactly does ethereum complete these transactions on the blockchain? “ethereum runs smart contract code when a user or another contract sends it a message with enough transaction fees. The Ethereum Virtual Machine then executes smart contracts in ‘bytecode,’ or a series of ones and zeroes that can be read and interpreted by the network.” -Coindesk
This doesn't necessarily have to be related to fees. It can also just be a set of conditions which trigger the blockchain to complete the contract. This means that its uses can be endless because as long as there is an interaction between two parties that are agreeing on something, there is a place for a smart contract.
How Smart Contracts Are Applicable (example)
Smart contracts are a form of automation. “The classic example used to demonstrate smart contracts in the form of code executing automatically is a vending machine. Unlike a person, a vending machine behaves algorithmically; the same instruction set will be followed every time in every case. When you deposit money and make a selection, the item is released. There is no possibility of the machine not feeling like complying with the contract today, or only partially complying (as long as it is not broken). A smart contract similarly cannot help but execute the prespecified code. As Lessig reminds us, “code is law” in the sense that the code will execute no matter what. This could be good or bad depending on the situation; either way, it is a new kind of situation in society that will require a heavy accommodation period if blockchain-based smart contracts are to become widespread.” - Melanie Swan, Blockchain: Blueprint for a New Economy
They take out the necessity for a trusted third party. There are a couple of great examples of how this could work. One example is selling stuff on eBay. So you have just upgraded to a new phone, and you don't want your old one, so you go to sell it on eBay. eBay connects buyers and sellers and acts as that trusted third party. They have a market place, and they also have an escrow process.
Escrow is when a trusted and impartial third party holds onto funds until the transaction is complete and everything has been shown to be above board. However, they aren't doing this out of the kindness of their heart. They are doing this to make money.
An example of this on a larger scale is the purchases of homes or properties. Both the buyer and the seller of the property must trust an escrow company to ensure that payments are not fraudulent and that sellers are actually selling what is advertised.
Smart contracts get rid of intermediaries like this which are there to not only ensure buyer and seller protection but also take their cut. This, in turn, increases the cost of the transaction and also the inefficiency.
Because all of this is done on a blockchain through computer programs governed by logic, transparency is much greater and so is security. It will be the future of not just financial transactions but also contracts where terms and conditions are agreed upon.
Smart Contracts Can Scale Into Perpetuity
Conducting activities like this on a blockchain instead of through third parties allows for transactions to be scaled far beyond what is currently possible at the moment. As humans and businesses, we can only do so much. It is impossible for humans to work 24/7 all year round and the human capital required to do so if a business wants to gets very expensive very quickly.
Smart contracts take human fatigue out of the equation and replace it with a machine that never miscalculates and never gets tired.
All of these factors result in a very efficient and effective for dealing with agreements and contracts. It also is creating a public record of the transaction which cannot be tampered with. This adds a level of security that we have not previously had. Especially when two parties do not trust each other. In essence, it a fascinating time, and it will be interesting to see how this aspect of blockchain technology gets implemented into how we interact and get things done.
If you are interested in reading more about this, we suggest Blockchain A Practical Guide To Developing Business. It is a fantastic book that covers how blockchain could affect business, government, law, and our daily lives.