Smart Contracts Explained
Smart contracts are inextricably linked to blockchain (read this post to learn about blockchain). The most obvious function for blockchain is to use it as digital money. This is also why there are so many cryptocurrencies and why Bitcoin is so popular. However, the functions are endless, and this is all because blockchain allows for the creation of smart contracts. So, what exactly are smart contracts? And what are all these endless possibilities? This post will give you a detailed explanation.
What are smart contracts?
To begin this explanation of smart contracts, it’s crucial to know the exact definition:
“A smart contract is a programmed contract whose agreements are recorded in computer code on the blockchain. The contract is executed automatically without the need for (trust in) an intermediary. These agreements can always be viewed but cannot possibly be modified.”
A smart contract is therefore anything but a paper contract under which you put your signature with a pen, as we are used to doing. It is a fully digital contract, consisting only of computer code, which a programmer has programmed together for you. It contains all the information about the contract: the persons between whom it is valid, when the contract must be performed, when the agreements were made, etc.
In a nutshell, smart contracts are:
– Are fully digital
– Consist of computer code
– Are programmed on the blockchain
– Are executed automatically without intermediary
– Are impossible to change anymore.
This gives an abstract idea of exactly what it entails, so let’s make it a little less abstract with a simple example.
A simple example
The easiest example that a smart contract is perfect for is for a simple bet. Say Laura is a big fan of FC Barcelona, while Juan is a die-hard Real Madrid fan. The match between these two title contenders is coming up and Laura thinks FC Barcelona will win, but Juan is convinced that Real Madrid will win. Juan wants to make a 15 euro bet. If FC Barcelona wins, Juan pays 15 euros to Laura and if Real Madrid wins, Laura pays 15 euros to Juan. If there is a draw, nothing happens.
Without a smart contract, you make this bet on good faith and assume that the other person will pay nicely if they lost. Laura knows, however, that Juan can sometimes be a bad loser and if FC Barcelona wins because of an unjust penalty, there is a good chance she can kiss her money goodbye. With a smart contract this trust is not necessary, because it can all be programmed and recorded.
Laura and Juan agree to record the bet in a smart contract that is triggered by the official result as recorded by the RFEF (Real Federación Española de Fútbol. They both pay 15 euros to the contract (in cryptocurrencies) and set the contract so that Laura gets 30 euros from the smart contract if FC Barcelona wins and Juan gets 30 euros if Real Madrid wins. In case of a tie, 15 euros is automatically paid to both.
The contract is put on the blockchain, so it is automatically checked by all blockchain users, and it is therefore impossible to change it (Juan can therefore no longer determine that the result if FC Barcelona wins due to an unjust penalty). The moment the RFEF announces the official result, the contract will automatically come into effect and the winner will be paid his/her money.
An example like this shows that an intermediary platform such as Unibet or Toto will no longer be necessary. All these bets with “the house” can soon all be done on the blockchain directly with each other. The same applies to casinos. All the money (commission) that normally went to the house will now stay with the users.
Benefits of smart contracts
This example immediately brings up some of the main advantages of a smart contract. The biggest problem for the bet between Juan and Laura is that Laura is not sure if Juan will actually pay if FC Barcelona wins. They could, of course, choose to record a contract on paper themselves, but few people would enter into such a bet with each other. Moreover, even then Juan can refuse to pay and then a lawsuit could only lead to Laura getting her 15 euros. Not ideal, then, and Laura has to trust that her lawyer is better than Juan’s. Moreover, the bet on the smart contract is fixed as it was entered into.
An unjustified penalty, however unjustified it may be, cannot change the rock-solid agreement that the result officially announced by the RFEF determines who wins the bet. Moreover, everything happens automatically without the intervention of other people. The blockchain ensures that the smart contract is executed correctly.
The advantages of smart contracts
The smart contract is on the blockchain. The blockchain is a shared network. It is automatically verified by all devices connected to it. Therefore, these devices all have a copy of the blockchain. As a result, no one can modify the contract.
The contract is really entered into by yourself. There is no need to trust a bank, lawyer, broker or other intermediary. Therefore, these individuals cannot manipulate the contract to their advantage. Moreover, you do not have to worry about the other person trying to get out of the agreement. The contract is managed by the network and executed automatically.
A smart contract is secured by the best cryptography the world currently has. It is virtually impossible to hack it.
The smart contracts are fully automated. Some actions normally take a lot of paperwork, but can be done by a smart contract within a few seconds performed. This saves an awful lot of time and work. And the code is further developed every day, so it will only get faster in the coming years.
Because everyone has a copy of the blockchain, it is impossible to lose the contract.
Smart contracts are a lot cheaper than traditional contracts. This is mainly because there is no longer a need for middlemen (with sky-high hourly wages). For example, you no longer have to pay for a notary or lawyer to draw up the contract or ensure that the contract is executed.
Smart contracts are executed by machines. As a result, you have (almost) no human error.
Industries that could be shaken up by smart contracts
As we know, blockchain has the potential to do the same to banks as what the Internet has done to post offices and libraries. Our example of Laura and Juan shows that it can also shake up the gambling industry considerably, but it certainly doesn’t stop there. The possibilities are endless, and it can completely shake up almost any industry, just as the Internet has done.
A large part of modern trends can be found in the food industry. People are becoming more aware of what they put in their mouths and how it affects the planet, the environment and those less fortunate. Examples include Tony’s Chocolonely (who work to give cocoa farmers a fair price for their cocoa), Fair Trade and organic food. But who checks that the products you buy are actually organic or how well Tony’s Chocolonely actually pays cocoa farmers?
Currently, this is still done by trust, but thanks to blockchain technology and smart contracts, soon this can all be tracked automatically and completely transparently.
Smart contracts ensure that the path food has taken is fully transparent and cannot be changed. You can see exactly which farmers, which factories and which trucks your products have been in.
A chicken that comes from a laying hen factory is registered in this way and can therefore no longer possibly be sold as an organic chicken.
The farmers of Tony’s Chocolonely can honestly state how many euros they sold their cocoa for and in this way it is possible to see exactly which chocolate brand gives the most back to the cocoa farmers without this being manipulated.
In which industry is it even more important to be able to check where your product comes from? The clothing industry! Because how can you be sure that the Rolex you are offered is a real Rolex and not a fake? How do you know if that Gucci bag really came from the Gucci factory and is not a cheap fake? Using blockchain and smart contracts, you will soon be able to tell all this in an instant. Fake clothing will be able to be recognized instantly with a simple scan of the barcode.
Smart contracts combined with RFID allow you to see exactly where your Rolex or Gucci bag came from and whether it is a real product and not a cheap fake. You can see if a bag is actually made of real leather, for example. You can check if the car you buy second hand on marketplace is indeed from the year 2013 and has only 80,000 kilometers on the odometer.
Music and tickets
A major problem for musicians today is that their music can be downloaded for free anywhere. You might think that artists such as Justin Bieber and Ariana Grande are making enough money, but for them there are thousands of other artists who are struggling. In addition, their fame does not make it fair to “steal” their music. Platforms like Spotify and iTunes make up for a lot, but these intermediary platforms make millions on the backs of the artists. Again, smart contracts can make a difference.
An artist can put his/her song on the blockchain and stipulate in the smart contract that users can listen to the song for a micro payment (say, 0.1 cents). This eliminates the need for middlemen who charge commission on this.
Artists or entertainers put their tickets for concerts or performances on the blockchain. They program a maximum price into the smart contract. This prevents traders from buying up tickets in large numbers and reselling them four times over.
You might not realize it, but an incredibly large group of people on this planet are walking around without an identity. The country they come from has simply lost it or it has been tampered with to such an extent that a person from Kuwait has it on their passport that they are from Afghanistan. It seems self-evident to us having a nationality, but if we had to live without an identity for a year, you would only find out how important having an identity is. With smart contract it is possible to regain ownership of your identity without having to depend on a (rogue) government.
Your identity is recorded at birth on the blockchain, to which only you (and your parents) manage access. This can never be modified by anyone. Only you can add things to it, such as a recent photo. This way you can always prove that you are who you say you are.
No one can steal your identity anymore. Your identity is un-hackable and only your private key can access it.
It has been in the news a lot in the last election. Russia allegedly influenced the American vote and it would be a breeze for hackers to hack the entire voting system. In many countries there is still a lot of vote rigging going on. Presidents do not want to resign because they don’t believe the results. This could all be over with smart contract. Your identity is registered on the blockchain (see previous example) and you can cast a maximum of one vote for your favorite party via a smart contract from your computer. The blockchain keeps track of all votes so you can see live who is ahead without any paperwork. Everyone keeps track of the blockchain, so it is impossible to manipulate. The results cannot be disputed. Former presidents do not have to worry about being manipulated, they can resign peacefully.
This is just a small sample of the thousands of possibilities that exist thanks to smart contracts. Moreover, there are still many solutions that we cannot imagine today. When the Internet emerged in 1994, there was not a single person who could predict the Internet of Things. Other industries that can be completely revolutionized by smart contracts are: the housing market, the insurance market, the stock market, the gaming industry, the automotive industry and many more.
Platforms for smart contracts
Currently, there are several blockchains on which smart contracts can be easily built. Ethereum is the most well-known of these. Programmers can relatively easily program a smart contract on this blockchain using the Solidity programming language. Decentralized apps (dApps) therefore enjoy the advantages of the Ethereum blockchain, but also have to deal with its disadvantages. Because Ethereum is the most comprehensive platform for smart contracts, by far the most ICOs have been held on it.
However, Ethereum is not the only platform that ICOs are held on. NEO in particular is currently on the rise and there are several ICOs coming up that use the NEO platform. Other blockchains that can be used for smart contracts include Qtum, Waves, Omni and even Bitcoin (using a new technology called Rootstock).
More and more cryptocurrency exchanges are also using smart contracts so that they can make their services more decentralized.
Disadvantages of smart contracts
It is always tempting to see only the advantages in a new revolutionary technology like smart contracts, but nothing is without disadvantages. We therefore feel it is important to also highlight the disadvantages of smart contracts in this explanation.
Adaptation is impossible – We have already mentioned it above as perhaps the biggest advantage of smart contracts, but it is also a considerable disadvantage. Suppose you have entered a lease, but want to change it, this is not so easily done. Of course, there are ways to get out of it jointly in some way, but this will take a lot of work.
The code must take everything into account – In a traditional contract, there are always “ifs and buts” included. People spend years studying to get this down on paper, let alone when it has to be processed in programming language. So it is (still) very susceptible to human error.
The third party will not disappear completely – Despite the fact that the third party is no longer needed, it will not totally become completely obsolete. In particular, the demand for programmers will increase enormously, while the demand for them is already sky-high. This could make them even more expensive and the cost of drawing up a smart contract could therefore become prohibitive.
In addition, there are many other disadvantages to consider. What happens if there is a bug (flaw) in the code, causing something to be executed very differently than agreed? And how is it then determined that this was a bug? Who pays for the costs incurred as a result? And how do you stop a smart contract that is not correct? The technology is still in its infancy so there are still an awful lot of situations that have not yet been taken into account.
The future of smart contracts
All in all, the future of smart contracts looks very bright. It could have just as big an impact on our society as the Internet has. Just about every industry can be affected by it. Smart contracts can eliminate the need for middlemen, which saves a huge amount of cost and work, but it also puts many people’s jobs at risk.
For now, however, the biggest challenge lies in how to legally deal with smart contracts. There are still a lot of situations to think about that we don’t have a solution for and until these are solved, it’s just a matter of waiting for the revolution that smart contracts can bring about.
At Brickken we have a legal team with expertise in digital signature, blockchain audits and corporate. Thanks to this expertise, we are perfectly positioned at the forefront of blockchain technology and the implementation of smart contracts. If you have any questions, do not hesitate to contact us at firstname.lastname@example.org. We will be happy to answer your questions.