Smart Contracts: A Comprehensive Guide to Blockchain Agreements

Smart Contracts are digital contracts that is converted into computer code and stored on the blockchain. What makes smart contracts unique is the removal of the “human element” (to an extent), making it very difficult, if impossible, for third-party interference and manipulation.

Smart contracts allow for an individual to exchange money, property, shares, or anything of value in a transparent, conflict-free way while avoiding the nuances of an intermediary or third-party.

Smart contracts aren’t “technically” a new concept, having roots dating back to 1994. The concept of a “smart contract” is predicated upon cryptography. They can be used in various instances, ranging from financial derivatives to insurance premiums, breach contracts, property law, credit enforcement, financial services, legal processes, and of course crowdfunding agreements.

Smart contracts allow for an individual to exchange money, property, shares, or anything of value in a transparent, conflict-free way while avoiding the nuances of an intermediary or third-party.

This has been said to be the technology that will replace lawyers. While that sounds fancy and well, this is technically impossible, as the industry still needs lawyers to help facilitate negotiations to be able to get to the point in time where a smart contract is appropriate to implement. The two go hand-in-hand.

The History

In 1994, a legal scholar and cryptographer named Nick Szabo discovered that a decentralized ledger could be used for smart contracts. These are nothing more than “code” which are self-governing and execute upon the occurrence of certain events.

How It Works

The best way to understand how smart contracts operate is by the “apartment rental” example Ethereum’s founder Vitalik Buterin explained at a DC Blockchain Summit:

Suppose you rent an apartment from me. You can do this through the blockchain by paying in cryptocurrency.

1. You get a receipt which is held in our virtual contract; I give you the digital entry key which comes to you by a specified date.

(If the key doesn’t come on time, the blockchain releases a refund)

(If I send the key before the rental date, the function holds it releasing both the fee and key to you and me respectively when the date arrives.)

2. The system works on the If-Then premise and is witnessed by hundreds of people, so you can expect a faultless delivery. If I give you the key, I’m sure to be paid.

(If you send a certain amount in bitcoins, you receive the key)

3. The document is automatically canceled after the time, and the code cannot be interfered with either of us without the other knowing since all participants are simultaneously alerted.