What Are Smart Contracts?

One of the key technological innovations of blockchain 2.0 has been the development of what are called smart contracts. Smart contracts are computer code that is stored inside of a blockchain which encodes contractual agreements. Smart contracts are self-executing contracts with the terms of the agreement or operation directly written into lines of code which are stored and executed on the blockchain computer.

A multiplicity of different contractual agreements for the institutional foundations that our modern society and economy rely on. The example of a cup of coffee is given. There are many of contracts that need to be made in order to serve you a cup of coffee on the surface there is the contract made between the cafe and the customer. Before that transaction is possible the cafe had to make several contracts with employees, landlord, and various suppliers. You can go deeper by looking at the other contracts that were made: for example, the suppliers made contracts with transport companies, manufacturing plants, farms, employees, and so on.

Our current contracts rely on a third party to enforce the realization of the contractual agreement by all parties. However, smart contracts cut out the third party because it is both defined by the computer code and executed or enforced by the code itself automatically without discretion. These contracts are decentralized in that they do not subsist on a single centralized server but are distributed and self-executing across a network of nodes. By decentralizing the transactions, this will bridge the trust gap that exists between unfamiliar parties.

A smart contract can be compared to a vending machine. Unlike a person, a vending machine operates algorithmically. You provide the source input of money and product selection which the machine takes as input and simply executes on a rule automatically to produce the pre-specified output. The same instruction set will be followed every time in every case when you deposit money and make a selection the item is released.

The smart contract cannot be changed because it is not owned by a single entity and decentralized. Because the code cannot be altered it is often said that “Cod is law.”

The advantages of smart contracts are numerous.

  • Smart contracts are automatic.
  • Smart contracts are incorruptible.
  • Smart contracts enjoy independence from any central party because they are decentralized.
  • Smart contracts offer an extra level of certainty.