Smart contracts are blockchain-based digital agreements that have the power to:
1. auto-execute without being triggered by the agree-ers and
2. directly transfer funds from one party to another.
Many consider smart contracts to be a powerful tool that might transform even our day to day agreements with other people. Smart contracts are run on blockchain platforms, the most prominient of which is Ethereum.
Smart contract (noun): An agreement coded onto a blockchain which has the ability to 1. automatically execute upon 2. completion of specified terms and 3. transfer funds from one party to another.
Don’t worry, we know it’s a mouthful of rather vague terms. Let’s unpack:
These three things make smart contracts akin to “agreements with superpowers”, to quote Henning Diedrich in his book, "Ethereum." Smart contracts are decidedly different, and more efficient, than traditional pen and paper contracts.
Using a paper contract involves uncertainty, risk, and hassle. It is always possible that you, or the person you enter an agreement with, do not abide by the contract. For instance, the person supposed to pay you could refuse to. Handling these kinds of conflicts in our current legal system is both costly and slow.
Smart contracts do away with the need to enforce an outcome (in the legal sense). The code of a smart contract includes the power to transfer money from one party to another, so when the terms of an agreement are met the contract automatically completes payment. Think of it like a digital contract, but with an escrow service built in.
This makes the contract “trustless,” meaning that the contract does not require trust to be involved at all. With a pen and paper contract, you are forced to trust that the other party will fulfil their terms. When using a smart contract, you do not have to trust anyone. No one has to agree to pay you at the end of the contract, only in the beginning, when they first sign.
Right now, there are many platforms that host smart contracts. The largest is Ethereum, whose cryptocurrency (more accurately, cryptocommodity), called Ether, is the second largest by market capitalization behind Bitcoin. The Ethereum platform hosts smart contracts primarily written in Ethereum’s own coding language, Solidity. Another platform is the NEO blockchain, which is based out of China.
Smart contracts do have limitations, and they have yet to become widely accepted. Regardless of the word contract, it is unclear whether a smart contract will stand up as a legal document in court. Another possible issue is that smart contracts are permanent the second they are deployed to the blockchain. What if there is a problem with the underlying code that’s only identified after the fact?
It is likely that we will see many advancements in the usability and implementation of smart contracts in the coming months and years. Much of this progress is already underway.