What is a smart contract?

If you've heard of digital currencies such as bitcoin or Ethereum, then you've probably also heard of the blockchain - the global network of nodes, or computers, that allow digital currencies to be traded. On the blockchain, every single digital currency transaction is recorded on a public ledger. And this is where smart contracts come in, as the mechanism that governs this decentralized, cutting-edge form of currency.

If you're asking 'what is a smart contract?' then you're certainly in good company as it's been one of the most commonly asked questions in the digital space over the past year. So let's deep dive into what smart contracts are and how they are used.

What is a smart contract?

A smart contract allows digital currencies - or other forms of digital contract and transactions - to be self-executed on a computer-controlled trusted network.

When were they invented?

Smart contracts were invented in 1994 by a cryptographer, Nick Szabo, as a means of recording digital contracts and their data in code. When certain conditions were met, the contract was activated. The new approach acted to remove the need for third-party, trusted bodies - such as financial institutions. The only issue was that the blockchain didn't exist in 1994 - even though the theoretical concepts were in place.

By 2009, blockchain was in place thanks to Bitcoin. And several years later, other digital currencies such as Ethereum were in circulation, with smart contracts coming into play by 2015.

Key things to know about smart contracts

1. Smart contracts are written in computer code data
2. They operate on the blockchain, meaning that their data are stored publicly in an accessible ledger and on a permanent basis.
3. The contracts can be held between two or more people or entities.
4. Smart contract transactions are processed via blockchain, which enables them to be automatically sent without the need of a third party to administer the transaction.
5. The agreed transactions will only take place when the agreed conditions of the contract are met.

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What can smart contracts be used for?

The scope of smart contracts is as broad as the scope of blockchain itself - vast! The most obvious example might relate to digital currencies, but smart contracts can also be used for the sales of physical goods, where the transaction is being delivered via a digital currency. Here's an example:

Say Duncan wants to buy Scott's car. They make an agreement using bitcoin and a smart contract. The smart contract is between Duncan and Scott and it says 'when Duncan pays Scott 500 bitcoin, Scott will transfer the car ownership to Duncan'.

Once the agreement is in place, it is permanent and cannot be changed. Duncan can safely pay Scott the agreed price of sale without any trust issues. No third parties are needed - such as banks, brokers or legal advisors. No commissions are paid, no delays result and there are no third-party administration issues.

Once the condition of the contract is met - e.g. the payment is initiated, the contract is automatically executed.

Already, smart contracts are being used for insurance sales, financial services and trades, legal processes, credit approval, crowdfunding arrangements and supply chain management. Businesses can run their payroll using blockchain smart contracts and governments can manage voting processes fairly and accurately. These are just some of the myriad examples that show the huge scope and application of this fascinating technology.

How blockchain makes smart contracts possible

Trust

Because smart contracts cannot be changed once agreements are in place, they are inherently trustworthy. This is because they are recorded in the shared database of the lockdown which is owned by a vast number of people (decentralised) and not under the control of any entity, government, company or individual.

Enhanced cybersecurity

Its decentralised nature also means that it's basically impossible to hack the blockchain, vastly improving cybersecurity. For a hacker to attack the blockchain itself or its smart contracts it would need to be able to successfully hack into over 50% of the nodes on the system.

How are smart contracts initiated?

Smart contracts can be built across a variety of blockchain platforms, such as NEO and Ethereum. They are developed in the platform's coding language. this is just one reason why the demand for coders is rocketing as the world locks on to the vast potential of digital currencies, blockchain and smart contracts.

How smart contracts could change our world

Because smart contracts remove the need for third parties, there are potential benefits to be had. For example:

  1. Customers will no longer need to pay commission to intermediaries. Consider how many third parties can be involved in complex transactions, such as a house sale, and you can see just how much scope there is to strip out third-party middleman costs and time.
  2. Transactions can be far quicker without middlemen and their own checks and processes
  3. Fraud is reduced and cybersecurity improved thanks to the decentralised, permanent and open-access nature of blockchain.

Find out more

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