What is a smart contract

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What is a smart contract

Smart contract is a computer algorithm designed to conclude and maintain self-executing contracts executed in the blockchain environment.

Such contracts are recorded in the form of code existing in a distributed registry – a blockchain that is maintained and managed by a network of computers. In simple words, smart contracts allow you to exchange assets without resorting to the services of intermediaries.

What is the catch of smart contracts

Smart contracts make it possible to carry out reliable and confidential transactions without the participation of external intermediaries in the person of banks or government agencies. In addition, such transactions are traceable, transparent and irreversible.

Smart contracts not only contain information about the obligations of the parties and sanctions for their violation, but they themselves automatically ensure the fulfillment of all conditions of the contract.

How did smart contracts come about

The first ideas for smart contracts were proposed in 1994 by Nick Szabo. He described the smart contract as a computer protocol that, based on mathematical algorithms, independently conducts transactions with full control over their implementation.

For the first time, Szabo’s ideas were put into practice with the advent of the first cryptocurrency Bitcoin and the underlying blockchain technology. Some principles of smart contracts were laid down in the Bitcoin protocol. However, most modern blockchains, including Bitcoin, do not have Turing completeness, so their “contracts” are relatively simple constructions, such as multi-signature or delayed execution transactions.

Smart contracts have gained widespread practical use with the advent and development of the Ethereum project. In 2013, its future founder Vitalik Buterin came to the conclusion that bitcoin is not suitable as a basic protocol for smart contracts, since it was not originally designed for this task. Subsequently, Buterin decided to create from scratch the most suitable protocol for smart contracts.

How does a smart contract work and what are its mandatory elements

Typically, a smart contract is written to the blockchain, where all its logic is placed in a software container – a block. The latter combines all messages related to a specific smart contract. Messages can act as inputs and outputs of the smart contract program code and lead to some actions outside the blockchain, in the real or digital world.

Mandatory attributes of a smart contract:

  • The use of electronic signature methods based on public and private keys available to two or more parties to the agreement;
  • The presence of a private decentralized environment (for example, Ethereum), in which smart contracts are written and which supports the inputs and outputs for oracles that provide communication between the real and digital world;
  • The very subject of the contract and the availability of tools necessary for its execution (cryptocurrency settlement accounts, oracle programs, etc.);
  • Precisely described conditions for its implementation, which the parties to the agreement confirm with a signature, as well as the reliability of the source of digital data.

What are smart contracts

Depending on the degree of automation, smart contracts can be:

  • Fully automated.
  • With a copy on paper.
  • Mostly on paper, with some of the provisions transferred to the program code (for example, when only payments are automated).

Blockchain-based solutions are only at an early stage of development. Technologies are tested and refined, therefore, in practice, truly sophisticated smart contracts are not yet used. Today, the vast majority of smart contracts are of the third type, where only certain aspects of agreements are automated, in particular, the exchange of funds for property rights.

Where else can smart contracts be used

The potential opportunities and areas of use of smart contracts are wide – from simple multi-signatures to operations with derivative financial instruments. Multisig (multisig, escrow) is the simplest, classic example of a smart contract. With its help, counterparties who do not trust each other can freeze a certain amount of coins on the blockchain in such a way that, if necessary, to spend this amount, the signatures of more than half of the participants will be required.

Smart contracts are widely used in the field of primary coin distributions (ICOs). For example, a smart contract can be programmed in such a way that by sending cryptocurrency to the project wallet, crowdsale participants will be sure that in the event of a campaign failure their funds will be automatically returned; If the financial goal of the ICO is achieved, then the funds will be transferred to the developers. However, this will be done provided that a sufficient number of participants in the multi-signature (if provided) activate their keys, thereby personally confirming the integrity of the project.

The most promising areas of application of smart contracts are many experts include the financial market (banking, insurance, derivatives trading), accounting and auditing, supply chain management and logistics, registration of property rights, all kinds of voting, smart transport, digital identity, etc. D.

What are the benefits of smart contracts over traditional contracts

Proponents of smart contracts are convinced that many types of contractual relationships can be partially or fully self-fulfilling. Underlying smart contracts, cryptography provides a higher level of security than traditional law-based contracts. Smart contracts can reduce transaction costs, as well as eliminate the risks of ambiguous interpretations of conditions or unfair court decisions.

Thus, among the main advantages of smart contracts are:

  • Autonomy (to conclude and confirm the transaction, you do not need to look for an intermediary represented by a broker, bank, notary public, etc.);
  • Reliability and security (a duplicate contract is stored in encrypted form on the blockchain;
  • System security is guaranteed by mathematical laws and makes hacker attacks unlikely, as well as backdating of information);
  • Saving and speed – thanks to the blockchain, many intermediaries are eliminated and processes are automated;
  • Accuracy – thanks to automation and minimization of manual work, the likelihood of errors that often appear when filling out forms during the approval process and when manually performing various contractual operations is reduced.

Do smart contracts have flaws

Smart contracts are far from perfect: the blockchain infrastructure is still underdeveloped and there are critical errors in the code itself. In addition, there are still many gaps in the legal regulation of smart contracts, oracle programs are underdeveloped to ensure that the digital world is tied to the real world and provide the input data for the contracts to execute them. All this creates certain obstacles to the integration of smart contracts in the daily activities of organizations and individuals.

In some cases, smart contracts are less flexible than regular contracts. The information falling into the blockchain cannot be changed in the future; therefore, it is extremely important to observe the accuracy and reliability of the initial information, as well as to prevent errors during data entry.

In addition, many banks and large corporations are not comfortable sharing confidential data through open distributed registries. Also, the problems of scaling and transaction processing speed are still relevant.

The forces of many developers are aimed at solving these and other problems and limitations, and they are solved differently within different platforms. Progress does not stand still, and in the future many issues and problems will be resolved, and economic agents will completely move from drafting traditional contracts to their digital implementation and even to their implementation with the support of artificial intelligence.

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