What Are Smart Contracts?
A smart contract is a digital agreement stored on a blockchain network that automatically executes when the contract’s specified terms and conditions (T&C) are met. These T&C are coded in blockchain-specific programming languages like Solidity.
Smart contracts can also be viewed as blockchain-based applications that allow all parties to fulfill their roles in a transaction seamlessly. Applications powered by smart contracts are often referred to as “decentralized applications” or “dapps.”
While blockchain technology is widely recognized as the foundation of Bitcoin, it has since evolved into a powerful tool with diverse applications. For example, a manufacturer needing raw materials can use smart contracts to automate payments, while the supplier can schedule shipments. Once the agreed-upon conditions are met, such as the dispatch or delivery of goods, payments can be automatically transferred to the seller.
History of Smart Contracts
The concept of smart contracts was first introduced in 1994 by Nick Szabo, a U.S.-based computer scientist who also developed a virtual currency called “Bit Gold” in 1998, a decade before Bitcoin’s emergence. Szabo described smart contracts as digital transaction protocols that enforce the terms of a contract.
Many of Szabo’s predictions in his paper have become integral to our lives, even before the advent of blockchain technology. However, the implementation of smart contracts was initially impossible due to the lack of the necessary technology, particularly distributed ledger systems.
In 2008, Satoshi Nakamoto introduced blockchain technology in a whitepaper, paving the way for the development of smart contracts. The breakthrough came in 2013 when the Ethereum blockchain platform made the practical use of smart contracts possible. Today, Ethereum remains one of the leading platforms for smart contract implementation.
How Do Smart Contracts Work?
A smart contract, like any traditional contract, is a binding agreement between two parties. It uses code to harness the benefits of blockchain technology, offering greater efficiency, transparency, and security. Smart contracts operate based on simple “if/when…then…” statements written into the blockchain’s code.
Here’s how smart contracts work:
Agreement: The parties involved must agree on the terms and conditions of the transaction. They also need to decide how the smart contract will function, including the criteria that must be met for the contract to execute.
Contract Creation: The smart contract can be created by the participants themselves or with the help of a smart contract provider. The contract’s terms are encoded using a programming language. During this phase, it’s crucial to thoroughly verify the security of the contract.
Deployment: Once finalized, the smart contract is uploaded to the blockchain, similar to how regular crypto transactions are processed. The contract’s code is embedded in the data field of the transaction. After verification, the contract becomes active on the blockchain and cannot be altered.
Monitoring Conditions: The smart contract continuously monitors the blockchain or another reliable source for the predefined conditions or triggers. These triggers could be anything that can be digitally verified, such as a payment being made or a specific date being reached.
Execution: When the specified conditions are met, the smart contract is executed according to the “if/when…then…” logic. This could involve one or more actions, such as transferring funds to a vendor or registering the buyer’s ownership of an asset.
Recording: The results of the contract’s execution are immediately recorded on the blockchain. The blockchain verifies the actions taken, logs their completion as a transaction, and stores the finalized contract on the blockchain. This record is permanently accessible.
