What are smart contracts?

If you have been researching crypto projects, then you have run across the term “smart contract” a million times. What is it, and why is it such a big deal?

As it turns out, it is nothing all that special - just a digital version of a contract. Two parties agree on something (these two parties can be individuals, or companies, or even pieces of software exchanging data), and the contract executes the exchange. What makes a contract smart, is the elimination of the middle man, whereas a traditional paper contract has lawyers, notaries, brokers, or other trusted intermediaries who take a sizeable fee for their services. Using this new way to create contracts is smart, as it excludes these additional expenses.

Smart contracts exist alongside something called a distributed ledger, otherwise known as a blockchain. This distributed ledger is a simple record of account balances on a certain network.
The smart contract just moves the numbers (or assets) from one account to the other. Unlike a private database, a distributed ledger is typically open for anybody to see. It can be configured any number of ways, but typically there is no personally identifiable information in public view, just a simple account number, balance, and transaction history.

Practical Uses

If you want to buy a house, you need a real estate agent, a real estate broker, title insurance, and an escrow company to complete a typical transaction. That is a lot of hands taking a piece of your hard-earned money. If the Department of Housing (or county records) would use a distributed ledger to declare what property belongs to whom, a smart contract could handle the transaction on its own, without any of these additional agencies or people. The buyer would fill out the information required on a web page, which would send a confirmation agreement to the current owner via email. The current owner would click a link to sign off on the document, and the smart contract would move the house to the new owner’s account on the distributed ledger. The smart contract would then withdraw the money from the buyer’s bank account (or from the approved lender’s account) and transfer it to the current owner. All this would occur within seconds, instead of weeks.

Another example of a smart contract in action is the creation of an employee shareholders program in an existing company. Let’s say after years of success, the owner wants to give a piece of the company to the people who helped build it. The hypothetical owner decides to create 500,000 shares, which will be distributed to each employee who has been there for longer than 3 years, and for every day they worked, they get 1 share. The smart contract would check payroll records, easily determine who is entitled to what, create accounts on a stock management service, and then distribute the appropriate amount of shares to each employee. Lastly, it will notify each employee by email of their new account information and balance. It would then vest the remainder of the shares in a general account, waiting for new employees to hit the 3 year mark before distributing to them their portion.

In the future, when autonomous vehicles become part of regular daily life, these vehicles will be self-maintaining, driving themselves to the car washes, mechanics, and paying for their own parking and storage. The car will have its own digital wallet, which it will use to pay for these services via smart contracts between the car and electric station, between the car and car wash, or between the car and mechanic, and so on. The mechanic would simply calculate the cost on his phone app, scan the QR code on the car, and send it a bill, which would be paid immediately via the smart contract infrastructure.

While smart contracts are a pretty basic thing, their existence can cause major disruption and evolution in the way many things are done in society. Although it could have some negative impacts in terms of employment and job losses, in terms of saving individuals and companies time and money, it is a positive step within the evolution of contracts. In terms of finances and agreements, this is up there with the invention of the wheel.