By: Sameer Zubairi | 4 min read | 07/12/2018

What are Smart Contracts?

Smart contracts are digitally binding terms written in computer code and executed on a blockchain network. The concept of a smart contract was first introduced by the American legal scholar and cryptographer Nick Szabo in a paper he released in 1994. Szabo realized that a decentralized ledger could be used to introduce self-executing contracts. He suggested that legal contracts could be converted to computer code and even launched “Bit Gold” in 1998, a digital currency that could be used to execute smart contracts.

The blockchain network provides an information channel that is both secure and highly accessible from anywhere on the planet. These features make it a useful framework to implement smart contracts, which can behave as a personal dealing between two interested parties in a completely trustless process. This has a significant impact on the costs and time involved in enforcing complicated contractual obligations. The clauses of the contract can simply be turned into computer code and executed on a highly secure blockchain network, meaning the transactions occurring are transparent and can easily be validated. Therefore, it is easy to hold all parties involved accountable.

USING BLOCKCHAIN INSTEAD OF A MIDDLEMAN

The blockchain network is designed in a way which allows any two people on the network to interact with each other in a trustless way. Trustless, in this case, means removing the need for trust since the information being processed through a blockchain network can be masked using encryption which hides anything personal.

This means that valuable collateral can be exchanged over the network without the threat of hackers uncovering the personal information of the users involved. In this case, the two parties no longer need to trust each other, just the smart contract. Therefore, smart contracts are self-executing and can involve complex terms that would normally require legal steps to be taken.

Removing the middleman from transactions significantly reduces the time and costs involved with enforcing contracts. Complex dealings like leases, loans, or even the management of property can be coded as clauses in a smart contract, making these transactions much more accessible and efficient.

THE PROS AND CONS OF SMART CONTRACTS

We have discussed many advantages of smart contracts and their wide range of applications. The convenience alone can be a huge motivating factor. Not to mention, the reduced costs and bypassing of legal procedures make it even more appealing. Encoding these contracts digitally is what contributes to their convenience, but the involvement of blockchain allows for another major advantage. Retaining the privacy of the parties involved.

By keeping personal information encrypted on a blockchain network and using the consensus protocol to verify that the transactions of the contract do occur, smart contracts can allow anonymous parties to deal with each other. This trait makes this technology trustworthy enough to fulfill complex contractual obligations.

However, there are some disadvantages that should also be taken into consideration when it comes to mass integration of these contracts. For example, transactions involving physical objects as collateral require these objects to be digitally integrated. For example, the exchange of property, like a house or car, would require a secure digital key that makes them accessible. This would allow both parties to be held accountable since both the cryptocurrency wallet and the digital key can act as collateral in the exchange. Unfortunately, this level of digitization is just not a reality at the moment.

Additionally, while the bypass of legal obstacles can be a huge plus as far as convenience is concerned, it can also create a lot of regulatory challenges. The fact that complex contracts can be enforced completely digitally and no longer require arduous registrations and collection of personal information means that regulatory authorities will ultimately have less control over the exchange of such goods.

THERE’S A DAPP FOR THAT!

Similarly to how web-based applications use the internet to carry out different tasks, a decentralized application can do comparable things on a blockchain network. Decentralized applications involve the exchange of goods, services or even information between two parties over a distributed ledger network. This means that sensitive information can be kept private while transactions can still be verified in a secure way by running consensus protocols. The significant benefits are that decentralized applications are more robust against hacking, since the information is verified by thousands of nodes on the network, and due to encryption tools offered on blockchain networks, sensitive personal information can be exchanged privately.
There are many stores on the internet that offer services in the form of decentralized applications.

This includes online games where items in the game can be of real value in the form of cryptocurrency, such as Etheremon, a world of monsters where you can breed and fight with unique monsters, or sell them for ETH on the marketplace. Many financial decentralized applications are also gaining steam. Stablecoins, for example, use a smart contract which pegs the exchange rate of its underlying currency to a fixed amount and back it with collateral gathered through loans. This removes volatility and helps draft a complex loan structure quickly. To look through a catalog of dApps, we recommend visiting State of the Dapps.

All in all, there are a few hurdles for implementation, but as far as smart contracts are concerned, there is a revolutionary characteristic with regards to the convenience and security that is offered which make them incredibly appealing.

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