What is a Smart Contract? A Guide for Professionals

What is a Smart Contract? A Guide for Professionals

Introduction to Smart Contracts

A smart contract is a computer-programmable agreement that can execute contractual relationships between parties to a contract or application on a public or private blockchain. It operates based on the terms of the agreement laid down by the developers in a machine-readable and execute language such as solidity.

The primary purpose of creating smart contracts is to eliminate intermediaries and the costs extensively incurred on them along with the development of electronic – commerce. The smart contract also provides “escrow services”, which means that it can store money, documents, ownerships in its system and distribute them to the concerned parties at the right time. The terms of trade can be pre-programmed, including those that are specially designed for a particular transaction. 

For example, let us say that Mr Arul wants to buy a piece of land with an amount that he has saved for the same purpose. In the absence of Smart contract, he would hire a real estate agent to make things easier for him. The agent takes care of the legal formalities involved in purchasing the land, fixing a fair price, and he would show Mr Arul the best pieces of land that he can intermediate. He would charge 6% (the prevailing rate) for his services. This happens to the seller as well.

Now, if the seller and the buyer (here, Mr Arul) use smart contract instead of the agent, they can fix their terms of the agreement and most importantly they can save the cost that they pay the agents. The responsibilities of the agent will be pre-programmed in the smart contract.

Smart Contract – Through the ages

The term “smart contract” was created in the year 1994 by an American computer scientist Nick Szabo. He said that “smart contracts are computerized transaction protocols that execute the terms of a contract”. Later, in 1998, he also found the concept of “Bit Gold”. Bit Gold was a form of virtual, digital currency, just like Bitcoins. Bit Gold was never implemented. Based on Bit Gold’s model, Bitcoin was created in the year 2009 by Satoshi Nakamoto.

The first and most successful smart contract platform to be built is Ethereum. Ethereum has its cryptocurrency called “ether”. It is the second-largest cryptocurrency platform in the world after Bitcoin. It was found by Vitalik Buterin in the year 2013 and was implemented on 30th July 2015. So far, Microsoft’s business partnership with Consensys remains the biggest project of Ethereum.

Smart Contract – Work Flow

As mentioned earlier, the smart contract contains the terms of the agreement between the two parties. It is pre-programmed to implement all the “if-then” functions; for example, if Mr Arul pays the said amount for the piece of land, then the property rights over the land (the escrow) will be transferred to him. If he fails to pay the amount, the property rights would not be transferred unless until he pays the amount. Smart contracts are programmed to “automatically” serve once all the terms are met. It accelerates the process, removes the intermediaries and cuts down the costs incurred on them. It conducts transaction in the most transparent and dispute-free manner.

The smart contract uses the blockchain technology, which involves a decentralized system. A decentralized system means that it is not controlled by a single party, but by many computers (usually referred to as nodes) which shares the database. It is impossible to hack a smart contract because it has many computers which share the database and a hacker must at least hack 50% of those to cause changes in the program. This distinctive characteristic of smart contracts makes them trustless, fair and very safe and secure.

On the primary level, smart contracts can be programmed to carry on the following functions:

  • Perform calculation – it can calculate the net amount after the interest, gross amount and the interest.
  • Storing of information – it stores records on the past transactions, membership details, terms of the agreement, etc.
  • Facilitate transactions – it transfers money for the payment of goods and services, property, anything of value to other accounts and at the same time, it transfers the property rights as well.

A critical advantage of smart contracts alongside being cost-effective, time-efficient, safe,  self-operating, conflict-free is that a document is duplicated many times in the blockchain system and so there is no need for the unnecessary fear of losing any document.

Applications of smart contract 

  • Insurance companies – When a person takes insurance, he pays an amount called the insurance premium to the insurance company. The insurance amount will be in the smart contract, when the customer is in need, as per the terms of agreement (e.g.-theft), the amount gets transferred to the account of that person, if not; the amount gets transferred to the account of the insurance company.
  • Medical industry – smart contracts are used in the medical industry to store the patient records safe, to make the patients control their data and make it impossible for the third parties to hack. If researchers need those data, they have to seek the permission of the concerned patient, and they also have to pay for it.
  • Fair election – During the times of election, individual votes are stored in the smart contract system using blockchain technology. This way, there is no way to hack and make changes in the votes that are cast. Thus, a smart contract ensures a fair election because there is no scope for fraudulent activities to take place.
  • Business organizations – Business organizations save money and time by using a smart contract to pay salaries and wages for their employees instead of paying the staff to do the same. They program smart contract to pay the employees their salaries at the exact time and the amount the business has to pay. The problem of the underpayment is eliminated. A smart contract can also be used for recording the stock-keeping; it is beneficial in the tracking of the stock and to be aware of the stock that has gone missing.
  • Ownership – Smart contracts are used for recording and storing the ownership of property. The need for agents and other intermediaries are removed due to smart contract; this saves a lot of money and time.

The Future of Smart Contracts

Smart contracts help eliminate the intermediaries. In the future, when the world operates on smart contracts, the middlemen would vanish. This would result in the reduction of the costs of the transactions. All the documents would be very safe, and the possibility of them getting lost will be reduced to almost zero. The frauds that take place in transactions would be cut down significantly; they would be safe and fair. The terms of the agreement will be followed accurately.

Data would be stored extensively in smart contracts; underpayment of wages would seldom happen. The world would be a “democratic” place with smart contracts in it. Payment for goods and services, sale and purchase of the property would be in the form of smart contracts.

In simple words, anything that has value will be transacted through smart contracts. Loss of jobs to the middlemen would be problematic, especially in the overpopulated countries with an already high unemployment rate.

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