Bitcoin (BTC) emerged in 2009 as a revolutionary way to transfer value without a third-party intermediary. Gaining attention for its promise to enable value and asset transfer across a wide range of industries and use cases – and its potential to disrupt financial institutions, remittance companies, and lots of other transactional middleman businesses. Smart contracts work hand-in-hand with blockchain technology and can potentially automate and disrupt processes in many industries.
According to Vitalik Buterin, a smart contract “is a computer program that directly controls some digital asset.” Buterin, co-founder of Bitcoin Magazine, is the 22-year-old programmer behind Ethereum, a blockchain technology that has been heralded as Bitcoin 2.0, serving as the primary foundation for smart contracts.
Nick Szabo, an American computer scientist who invented a virtual currency called “Bit Gold” in 1998, defined smart contracts as computerized transaction protocols that execute specific terms.
What Makes a Contract “Smart”?
Where a traditional legal contract defines the rules around an agreement between multiple people or parties, smart contracts go a step further and enforce those rules by controlling the transfer of currency or assets under specific conditions.
Like traditional legal contracts that are standardized, many types of smart contracts will one day become standardized.
- Smart contracts are self-executing contracts with the terms of the agreement between buyer and seller directly written into computer code.
- Smart contracts render transactions traceable, transparent, and irreversible.
- Smart contracts hold the potential not only to execute automated processes but also to restrict behavior.
- Insurance - One use case for smart contracts involves the autonomous vehicle or self-parking vehicle. Insurance companies will be able to provide temporal liability insurance. Using smart contracts, an insurance company could charge rates differently based on where and under what conditions customers are operating their vehicles, for example
- Real Estate - Instead of transferring payment for the property through an escrow account, buyers would send payment to a ledger in a blockchain system.
- Supply-Chains - Smart contracts will also be useful in supply-chains.
How Smart Contracts Work
First proposed in 1994 by Nick Szabo, an entire decade before Bitcoin’s invention, Szabo is speculated by many to be the true Satoshi Nakamoto, the anonymous inventor of Bitcoin, but he has denied these claims.
Szabo first defined smart contracts as computerized transaction protocols that execute the terms of smart contracts: he wanted to extend the functionality of electronic transaction methods, such as POS (point of sale), to the digital realm. In his paper, Szabo also proposed a contract for synthetic assets, such as derivatives and bonds.
In simple words, he was referring to the sale and purchase of derivatives with complex terms. Many of Szabo’s predictions in the paper came true in ways preceding blockchain technology. For example, derivatives trading is now mostly conducted through computer networks using complex term structures.
What Is a Smart Contract?
A smart contract is a self-executing contract with the terms of the agreement between buyer and seller directly written into computer code. The code and the terms of the agreement therein exist across a distributed, decentralized blockchain network. The code controls the execution, and transactions are trackable and irreversible. Smart contracts permit trusted transactions and agreements to be carried out among disparate, anonymous parties without the need for a central authority, legal system, or external enforcement mechanism.
Although blockchain technology has come to be thought of primarily as the foundation for Bitcoin, it has evolved far beyond underpinning the virtual currency, and smart contracts are a prime example of that.