What Are Smart Contracts

Smart contracts help you exchange money, property, shares, or anything of value in a transparent, conflict-free way while avoiding the services of a middleman.

The best way to describe smart contracts is to compare the technology to a vending machine (an example Vitalik Buterin often gives). The terms of an agreement are set up, a candy bar costs $1.00. You input the dollar and out comes the candy bar. The system is predetermined, automated, and unbiased. Ordinarily, you would go to a lawyer or a notary, pay them, and wait while you get the document. More so, smart contracts not only define the rules and penalties around an agreement in the same way that a traditional contract does, but also automatically enforce those obligations.

There are three steps to a smart contract.

  1. An option contract between parties is written as code into the blockchain. The individuals involved are anonymous, but the contact is the public ledger.
  2. A triggering event like an expiration date and strike price is hit and contract executes itself according to the coded terms.
  3. Regulators can use the blockchain to understand the activity in the market while maintaining the privacy of individual actors’ positions.

Suppose you rent an apartment from me. You can do this through the blockchain by paying in cryptocurrency. You get a receipt which is held in our virtual contract; I give you the digital entry key which comes to you by a specified date. If the key doesn’t come on time, the blockchain releases a refund. If I send the key before the rental date, the function holds it releasing both the fee and key to you and me respectively when the date arrives. The system works on the If-Then premise and is witnessed by hundreds of people, so you can expect a faultless delivery. If I give you the key, I’m sure to be paid. If you send a certain amount in bitcoins, you receive the key. The document is automatically canceled after the time, and the code cannot be interfered by either of us without the other knowing since all participants are simultaneously alerted.

You can use smart contracts for all sort of situations that range from financial derivatives to insurance premiums, breach contracts, property law, credit enforcement, financial services, legal processes and crowdfunding agreements.