Blockchain is a disruptive technology that the world is constantly learning about and discovering new applications for. One such application are smart contracts. A term that doesn’t really say much. What exactly are these smart contracts?
Smart contracts – definition
The dictionary definition says that a smart contract is a computer protocol designed to digitally facilitate, verify, enforce the negotiation or execution of a contract. Smart contracts allow you to perform reliable transactions without a third party. Lots of difficult words that just muddle a pretty easy issue.
Smart contract as an intermediary
But let’s try to illustrate a smart contract through an analogy. Suppose you want to buy a house. To do so, you use the services of a real estate agent, who helps you find the perfect place and guarantees you the safety of the transaction. The problem with realtors, however, is that they take a commission of up to several percent of the value for their services. Wouldn’t it be better if you could eliminate the realtor from the equation?
That’s what smart contracts are ideally suited for. The blockchain technology used in smart contracts allows you to secure both money and ownership in the system and then distribute it to two parties at the same time, so there’s no risk of someone cheating you. Moreover, smart contracts are verified by thousands of people, and this only confirms the flawlessness and security of the transactions.
The concept of smart contracts was proposed back in the mid-1990s by well-known cryptographer Nick Szabo (whom some still suspect to be Bitcoin creator Satoshi Nakamoto). Szabo had a degree in computer science and law, so he was looking for technological solutions that could streamline legal contracting.
For a long time, however, no one but Szabo was doing advanced work on smart contracts. The breakthrough came in 2009, when Bitcoin was created. The first cryptocurrency drew many solutions from a decentralized currency proposed by Szabo in 1998 called Bit Gold. Today, smart contracts are mainly associated with virtual money and, above all, with Ethereum, created in 2015, which promotes smart contracts as one of its most important features.
Example of smart contracts code
Smart contracts can be coded on any blockchain, but Ethereum is most often used for this, because it offers almost unlimited processing possibilities.
The example above is the code for the TokenSale smart contract. It is an easy smart contract that allows users to buy and sell tokens for 1 ETH. This is just one of millions of written smart contract codes based on the Ethereum blockchain.
Pros and cons of smart contracts
The concept of smart contracts is generating interest in the financial sector due to the wide range of potential applications and the multitude of advantages of this solution.
A smart contract guarantees users:
- CONFIDENCE – documents, funds in the concluded contract are encrypted and secured in the system. Smart contracts eliminate the “human factor”: you do not even need to know the other party to conclude a contract
- SECURITY – well implemented smart contracts are extremely difficult to hack. According to researchers, the cryptography behind smart contracts guarantees much greater security than, for example, bank transfers
- EFFICIENCY – using blockchain technology saves a lot of time and allows you to make transactions from any corner of the world without using intermediaries
- AUTONOMY AND SAVING – elimination of third parties also allows for much greater independence, basically full control over the course of the contract and much lower costs
- ECONOMY – in an ideal implementation smart contracts eliminate unnecessary paperwork, engagement of advisors, notaries, offices etc.
However, the world is not perfect and the problems and challenges faced by this concept need to be resolved before greater global adoption of smart contracts:
- REGULATORY VULNERABILITY – as of today, few countries are working on legal regulation of smart contracts at all, let alone introducing regulatory provisions. For smart contracts to work across industries, they need the creation of a clear legal framework
- CODING – smart contracts themselves are extremely secure, but behind the blockchain there are people writing code who may make mistakes leading to exploitation by hackers (for example, the DAO example)
- SCALABILITY OF THE NETWORK – one of the biggest challenges facing blockchain developers is the issue of transaction processing speed and scalability.
Application of smart contracts
Smart contracts, if only properly implemented, have great potential. Although the real revolution is yet to come, the concept is already being talked about as something that will replace lawyers and notaries.
The advantage of smart contracts is that while some associate them with cryptocurrencies (which legislators, authorities and banks around the world are still skeptical about), they actually have little to do with them.
Smart contracts can be primarily useful in:
- voting systems
- supply chain
- combating counterfeiting and trade in stolen goods
- real estate
- health care
- and many, many other branches of economy.
Smart contracts have already been used by Swiss banking giant UBS, Credit Suisse, the UK’s Barclays, the Swiss stock exchange SIX and Belgium’s KBC, among others, creating the Madrec (Massive Autonomous Distributed Reconciliation) platform in 2017 to make it easier and faster for banks to analyze potential credit risks.
The same year saw the creation of MediLedger Network, a decentralized network for the pharmaceutical industry that draws heavily on blockchain technology, largely basing its operations on smart contracts. Pfizer, Genentech and Bayer, among others, are working with the platform.
These are just two of many implementations of smart contracts in industries worth hundreds of millions. More smart contract applications are coming and are set to revolutionize how we think about contracting.