By: Sameer Zubairi | 5 min read | 07/12/2018

What are Smart Contracts?

NICK SZABO’S SMART CONTRACTS AND BIT GOLD

The term smart contract was first introduced in a paper released in 1994 by an American legal scholar and cryptographer named Nick Szabo, who created the term to refer to digitally self-executing legal contracts. Szabo also proposed the concept of Bit Gold, launching it 1998, twenty years before Bitcoin, which was a digital currency used to carry out complex legal clauses in the form of smart contracts. The idea was to take the functionality of electronic transaction methods to the digital realm. Some of these ideas came to fruition before the launch of cryptocurrency. For example, Szabo suggested implementing complex term structure derivatives trading using smart contracts. It was implemented before the creation of blockchain technology and is how derivatives trading commonly takes place.

Nick Szabo was able to realize the power of the decentralized ledger when it comes to executing complex terms and conditions. The clauses of a legal contract can be converted to computer code, which can then be stored and supervised by the network of computers that run the decentralized ledger. Again, this is all prior to the release of blockchain technology and is also why Nick Szabo is rumored to be the famously unknown creator of Bitcoin, Satoshi Nakamoto.

SMART CONTRACTS IN THE CRYPTO WORLD

Blockchain technology has been widely used to implement smart contracts in what is known as Decentralized Applications or dApps. There is an important distinction to be made here. Although Nick Szabo’s version of digital contracts can also be carried out over the blockchain network, the term smart contract means something slightly different in the context of cryptocurrency. Szabo’s smart contracts referred to the exchange of money, property, shares or anything of value, but the modern version of smart contracts apply to general purpose computational algorithms that take place on the blockchain or a distributed ledger network. This slight difference helps us realize the wide range of instances where smart contracts can be applied.

The role of blockchain in a smart contract allows for enforcement of the terms and conditions through a digital code which is verified by all the nodes on the network. It stands in sharp contrast to the central administrative permissions that most activity on the internet requires.

From social media to the exchange of pictures and videos, web-based applications need a central authorizer to validate user information, thus compromising privacy. Smart contracts offer the clear advantage of allowing such activity to be anonymously verified over a blockchain network, thus preserving privacy while still permitting a transaction to occur securely.

BUILDING OWN DECENTRALIZED APPLICATION

Blockchain technology is slowly becoming ubiquitous as a revolutionary way of making our day to day lives more efficient. However, to realize the implications of this technology can be difficult. To construct a whole new blockchain network to run an application requires in-depth knowledge of computer science, cryptography, and mathematics. Computer scientist Vitalik Buterin realized the same problem when he created Ethereum. Being the first altcoin, Ethereum was conceived as an accessible framework for developing blockchain-based applications. The Ethereum blockchain, in this case, acts as a network on which smart contracts can be executed. The underlying security and transparency offered on the Ethereum blockchain can serve as a validator for the terms of these contracts.

Many coins are built for this exact purpose. It has given rise to contract oriented computer languages, like Solidity, where smart contracts can be constructed and run on a blockchain network. Despite concerns about the Ethereum network having slow transaction speeds, the open source adoption of contract oriented languages like Solidity written using Javascript, and Vyper written in Python, are crucial steps for the sake of mass adoption of this technology. These platforms offer blockchain based solutions to a broader range of programmers and developers, rather than the few with the ingenuity and knowledge to reconstruct an entirely new blockchain.

ETHEREUM, EOS, AND BEYOND!

As mentioned earlier, the words Ethereum and smart contract have become inseparable in recent years. This is because the initial conception of coins like Ethereum is to provide interested developers API access to the blockchain network. This allows the development of decentralized applications which can execute smart contracts on this network. In fact, access to the Ethereum network even allows developers to launch their own token as a side chain of the network, to help launch an ICO (Initial Coin Offering) to raise awareness or funds for the project. These are all beneficial tools for those interested in blockchain development.

However, in recent years, there have been specific characteristics of Ethereum that have been called into question. It includes the proof of work consensus algorithm, which requires the completion of complex mathematical problems for the sake of validating a transaction. This protocol has been linked to the slow transaction speeds witnessed on this network. Ultimately, the result of such problems in the Ethereum network caused the creation of cryptocurrencies like EOS, the second largest Dapp building network.

EOS is a token based on the ERC-20 protocol, which is a technical standard used for implementing tokens on the Ethereum blockchain. The purpose of EOS is to improve the Ethereum development infrastructure by tweaking its consensus protocol. This network utilizes a delegated proof of stake algorithm instead, which selects a limited number of nodes in the network as trustworthy for validating future transactions. It saves a lot of time when processing transactions since miners no longer need to compete when trying to win the reward for generating new blocks on the network.

All in all, the launch of new ICO’s and blockchain projects around the world validate the ability of smart contracts to really unlock the potential behind this technology.

From interesting fads, like Crypto Kitties, which explore the idea of rare digital assets, to stablecoins like Dai, which is secured by collateralized loan agreements, the applications of blockchain are regularly being explored via smart contracts.

REGULATORY PROBLEMS AND LEGAL ISSUES

Once the implications of smart contracts become clear, these digital agreements become a legal elephant in the room. Technology that allows the exchange of goods and services between anonymous peers without the need of central authority can be a sensitive topic as far as regulations are concerned. There are limited barriers to stop money laundering efforts and criminal intentions from using blockchain technology to mask their efforts. Since cryptocurrency is largely untraceable, even if the wallet addresses are transparent, the movement of funds and execution of illegal contracts become much harder to detect. It is a significant hurdle for the mass adoption of smart contracts in a day to day life.

Nonetheless, it is essential to understand that the advantages of this technology can indeed be invaluable when it comes to executing complex tasks in a matter of minutes. The blockchain is transformational, but the way things are carried out traditionally makes it difficult to adapt in a major way.

Even if smart contracts make the development of applications more accessible, driving traffic towards these applications due to legal hurdles and regulatory issues is a whole other ball game. Hopefully, in the near future, smart contracts can be integrated into everyday life with collaborative efforts from governing authorities.

Disclaimer: This article is meant to be informative and is not supposed to provide investment advice. Please conduct your own research before making investment decisions.

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