What is a Smart Contract?

The idea behind ‘smart contracts’ was first put forth by American cryptographer and computer scientist Nick Szabo all the way back in 1998.

The term ‘smart contract’ has been doing the rounds on the internet over the last few years, especially as Ethereum – a prominent cryptocurrency that uses the technology at its core – has been gaining an increasing amount of traction across the digital finance landscape.  

In its most basic sense, a smart contract can be thought of as a self-executing piece of code that works exactly as per the conditions that have been outlined within it by two parties (i.e. a buyer and seller) after reaching common consensus. 

The idea behind ‘smart contracts’ was first put forth by American cryptographer and computer scientist Nick Szabo all the way back in 1998, a full decade before the world was even introduced to the concept of Bitcoin.

Furthermore, it bears mentioning that all of the data contained in a smart contract is completely immutable and can be freely accessed via its associated blockchain network seamlessly – thereby making it possible for all such transactions to be tracked with the touch of a button. 

So why Smart Contracts?

One of the most striking and obvious advantages of using smart contracts is that they allow for the facilitation of trusted transactions – monetary and otherwise – between two or more disparate, completely anonymous individuals without them having to rely on a central authority figure or external enforcement mechanism. 

This is in stark contrast to traditional contracts, which generally involve a number of companies, lawyers and middlemen going through several rounds of negotiations, with the final outcome being an agreement that may still be “open to interpretation” in case of a future legal dispute — since the contract is drafted using human language which is open to manipulation. 

In real-world terms, one can see the importance of smart contracts coming into play when we start talking about individuals from two ends of the world who may have never met each other or don’t know or trust one another trying to do business. 

For example, within the realm of traditional finance, it is safe to assume that a person would never even consider lending money to someone living in, let’s say Colombia or Guatemala, without the presence of a trusted intermediary. However, with smart contracts, not only is such a transaction possible but the presence of any middlemen is completely eliminated, thus allowing individuals to save on a substantial amount of settlement fees

How do they work exactly?

With each passing month, the complexity aspect related to smart contracts seems to be evolving at a rapid rate. However, at present, most platforms utilize smart contracts that are quite straightforward in their design, i.e. if an “x” event takes place or “x” condition is fulfilled, then step “y” should be executed. 

For example, within the domain of Decentralized Finance (DeFi) lending, a field that has grown at an unprecedented rate over the past year or so, a pertinent example would be one where, if an individual is able to fulfill a platform’s collateral requirements, then the system’s native smart contract can automatically issue a loan to the person without them having to go through the entire process of applying for a loan in a traditional manner that is used by banks and other similar institutions — which can typically take up to many days as well include heavy processing charges.

That being said, even when talking about smart contracts, it should be highlighted that in order for a contract to be executed – i.e. for its details added to the blockchain – a small transaction fee needs to be paid. In the case of the Ethereum blockchain, smart contracts are executed on the Ethereum Virtual Machine (EVM), and the above-stated payment, also known as “gas”, is done so in the form of GWEI, which essentially represents the smallest divisible unit of ether (similar to how cents are in relation to the US Dollar).

Key Takeaways

  • Smart Contracts can be envisioned as being automated lines of code that can execute the terms of a pre-defined agreement between two parties without the need for an intermediary.
  • Some of the world’s most prominent Smart Contract enabled blockchain ecosystems include Ethereum, NEM, Waves, Hyperledger Fabric and NEO.
  • Smart Contract-based blockchain transactions are not only traceable, transparent but also immutable in nature.

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