A smart contract is in fact a computer algorithm, an electronic protocol written with a programming code. Its main function is to transfer information, which ensures fulfilment of the terms of commercial contracts based on the blockchain technology.
A bit of history
The concept of smart contracts was first proposed by the cryptocurrency pioneer Nick Szabo back in 1996, but it could not be implemented until blockchain appeared in 2008. Bitcoin’s protocol included some principles of smart contract operation, but they were not implemented in the client software and had limited functionality. Developers of the Ethereum were the first to embody the full idea of smart contracts. Vitalik Buterin, the creator of this virtual currency, realized that blockchain can have a much wider application that just providing peer-to-peer decentralized payments in cryptocurrency systems. This technology can be universally applied to create different information and storage transfer systems. And whatever we do almost in any area of life were actually transfer the information. To make this transfer reliable and secure, this process could have o form of mathematic calculations.
How does it work and where it can be applied
Early in summer 2017, The Economist wrote that smart contracts have the potential to become the most significant application of the blockchain technology. So, smart contracts are, in fact, commercial deals and transactions. The main principle of the technology is a full automation and reliability of contractual relations. Smart contract provisions and performance results are described through algorithm. And parties do not need any other agents (banks, notaries, lawyers, courts, etc.). The security of these contracts is based on cryptography.
You can exchange various assets (money, cryptocurrency, property) directly using smart contracts. Traditional contractual relations are often interpreted ambiguously or make parties get stuck in the judicial swamp. Smart contracts are designed to get rid of all this stuff with cryptographic mechanisms ensuring security and contract performance.
Let’s say you ordered a T-shirt with the logo of your favorite band in an online store. The seller may worry that you will not take the parcel paid on delivery and he or she will then lose money for shipping. And you worry that the seller will not send you the T-shirt after you pay for it. Smart contracts can ensure the security of such a transaction automatically, thus, here, if you do not take the parcel, the seller will receive compensation, and if the seller does not send your T-shirt, you will automatically get the money back. In addition, all operations are made in a decentralized blockchain environment.
Is it really that smooth?
Well, smart contracts do have a number of advantages and are very promising, however, smart contract is still a computer program that can have bugs or be hacked. Moreover, traditional economy and commerce legal frameworks still dominate which means all these digital alternatives have an unclear legal status. Though smart contracts are really the “final instance” in the digital world, their legal force in “the real world” is an issue.
Anyway, smart contracts are an important and promising part of the blockchain technology. And today they are really one of the main columns of the new digital blockchain economy.