After watching this video, you will understand what a smart contract is, how it works and
why it is viewed as revolutionary.
I will cover in simple terms how smart contracts work, the benefits they offer and the challenges
they face.
I provide a short summary near the end with some visuals to help you get your head around
the concept – and I really hope you subscribe to this channel after watching this video.
A smart contract is very similar to a normal contract except that it is completely digital
– it’s a piece of computer code stored on the blockchain.
Because it’s completely digital, a smart contract doesn’t rely on a third party - it
removes the requirement to trust a third party.
Traditional contracts always rely on a third party.
For example, if I am going to rent a property from you, the estate agent will draw up a
contract that we will both sign.
I will then pay my deposit and my rent to the estate agent who will then pay it on to
you before you give her the keys, which she then passes on to me.
We are both trusting the estate agent (who is the third party in this instance) to give
the money and the keys to the right people.
A smart contract removes the need for the third party.
It is a secure online system for digitally verifying, enforcing or facilitating an agreement.
A smart contract is usually a piece of decentralised code that sends money when a certain input
is received and records all information securely on the blockchain.
So in our rental example, the smart contract might be programmed to hold my rental payment
until I have confirmed you have given me the keys.
Once I have provided that confirmation, the money is automatically sent to you.
Smart contracts force people to be honest.
I recently attended a talk by Henning Diedrich who said “Smart contracts are to legal,
banking and governance what the internet was to the music and film industries.”
So he clearly thinks they’re pretty revolutionary – and I have to say I agree.
In the next section, I’m going to cover the four major features of a smart contract,
followed by some of the challenges when it comes to using smart contracts in the real
world.
A smart contract is:
• Dependent on inputs.
An input is when someone confirms that whatever is specified on the contract has been completed.
Getting back to the example of renting a house, in this instance, the input would be when
I confirm that you have given me the keys to the house.
The smart contract would then be programmed to send you my rent.
• Exact.
The implications of the contract are pre-programmed on the blockchain.
There is no flexibility at all.
The system is programmed to perform an action (such as send money) once it has been triggered
by a specific input (such as a confirmation of services is submitted).
The system obeys its commands and only releases the money under pre-programmed parameters.
• Unstoppable.
The smart contract system obeys its commands under all circumstances, so if the input is
triggered, the output is going to happen – even if the input is triggered accidentally.
• Irreversible: if a smart contract is programmed to release a certain amount of cryptocurrency
when an action is triggered, then it will do so.
If you’ve accidentally sent the currency to the wrong account there is not much you
can do to get it back.
Smart contracts introduce the notion of trustlessness – you don’t need to trust any third party
to enforce or facilitate the contract.
They rely on “oracles”.
An oracle is anything that feeds inputs into the blockchain and they are necessary for
just about any smart contracts.
And many smart contracts are hosted on the Ethereum platform, which allows developers
to programme their own smart contracts.
Challenges of smart contracts
While smart contracts are promising as a technology that will revolutionise the legal and finance
industries (among others) they are not without their challenges.
Here are some of the issues facing smart contracts:
• Cryptocurrency: most smart contracts operate using cryptocurrency, which is incredibly
volatile – if the currency crashes mid-contract while the money is in escrow, one party has
lost a lot of money.
• We don’t know yet how to make smart contracts legally binding, especially since
lawyers tend to shy away from programming and smart contracts are recorded on nodes
(or computers) across many jurisdictions, which makes them tricky from a legal point
of view.
• And many people criticise smart contracts because they are so inflexible – the law
is actually very flexible – judges set precedent and reverse contracts all the time – this
can’t be done with smart contracts.
So, that’s smart contracts in a nutshell.
I hope you’re getting much more comfortable with blockchain technology and I really hope
you’ll subscribe to 4 Minute Tech and leave a comment – a lot of hard work goes into
producing these videos – we do it all for your subscribes and comments!!