What is a smart contract and how do they work?
Nick Szabo, who is credited with laying the ground work for the cryptocurrency bitcoin, coined the term “Smart Contract” in a paper published in 1997, however, the technology did not begin to take off until recently. Smart contracts are computer-programed contracts capable of self execution. Unlike traditional paper contracts, smart contracts are capable of interpreting inputs and conditions and automatically executing related contract terms.
Smart contracts are programed just like other computer programs operating on a “if-then” organization. When a condition is satisfied the smart contract program will trigger the response stipulated in the relevant contract clause. Originally, smart contracts lacked a real world practical application because banks and other financial institutions still required manual approval before funds would be transferred.
Smart contracts have become increasingly practical as bitcoin has become more mainstream. Because bitcoin does not rely on manual approvals from financial institutions, smart contracts have now opened the door to computer-programed initiated payments. Some of these platforms have become known as “Bitcoin 2.0 platforms” because they involve smart contract computer programs built on top of underlying bitcoin programs. These two programs work together to initiate and execute transfers of funds around the world instantly.
There are several smart contract platforms available including Codius, BitHalo, BlackHalo, BurstCoin, Ethereum, and Counterparty. Codius is being designed by Ripple Labs to work with Ripple Lab’s own cryptocurrency called Ripple. Ripple Labs is also aiming for Codius to work across a wide variety of other cryptocurrencies. Ethereum is being designed and deployed as a completely independent cryptocurrency system which would operate as a direct replacement to other cryptocurrencies such as bitcoin.
Practical applications and benefits
Similar to cryptocurrencies, smart contracts are grounded in a decentralized system that operate without the intervention or involvement of a third party. A system of smart contracts could help to drive down costs in a variety of industries. Tasks such as home mortgages could be significantly simplified. Wills and trust funds would no longer need teams of lawyers and bankers to execute.
The integration of smart contracts with Internet of Things (“IoT”) products and services has the potential to present numeous opportunities. These applications that combine smart contracts and IoT devices are often referred to as “smart property tokens.” Ultimately, these tokens could represent ownership or rights in property such as cars, houses, cellphones, or a rented apartment.
An example of this combination is a smart car that is rented out. Upon receipt of payment, the smart contract program could automatically unlock the doors of the vehicle. The smart contract program could also automatically disable the vehicle upon termination of the rental period. With IoT devices, unlocking the car would be possible through a smartphone, and no physical keys, contracts, or money would be required. The end result is that integration of smart contracts and IoT devices could eliminate significant transaction costs and reduce inefficiencies.
Smart contracts present a number of issues. Foremost, security is a major source of concern. In order to ensure long-term, widespread use, smart contracts will have to provide a sufficient level of security to prevent the possibility of fraud, hacks, and data breaches. There is also concern over how courts may approach smart contracts, conditional inputs, and faulty execution.
Finally, one of the biggest hurdles to widespread adoption is the development of a simple user interface. If non-tech savvy users are able to quickly and easily create and manage their smart contracts then the technology has tremendous potential. However, if the user interface is difficult to interact with or requires a certain level of technical know-how, adoption of smart contracts could languish.