What is a Smart Contract?

We are all familiar with contracts.  A traditional contract outlines the terms of the relationship between two parties and each party is held accountable to uphold their end of the bargain. Each party is then required to sign the agreement for it to be executed. 

A smart contract is similar to a traditional contract in that it establishes the terms of a relationship between two parties. However, a smart contract is written in code and that code is stored on the blockchain. 

Let’s take a further look at what that means:

A smart contract is tamper-proof. Once a smart contract is created, it cannot be changed. This is important for ensuring that the terms of the contract are carried out as agreed upon.

A smart contract is transparent, meaning that anyone can view the terms of the contract. However, the parties that use that contract can remain anonymous. 

A smart contract is secure. They are stored on the blockchain which is a distributed ledger. Since there are many computers in the network that make up a blockchain, there is no central point of failure. In addition, the data for each smart contract is encrypted which adds an extra layer of security.

How Do Smart Contracts Work

To understand how smart contracts work, let’s take a look at a vending machine. The vending machine has been programmed to list the price of the snacks offered. The consumer will then choose which snack they want and put that listed amount into the machine, and then receive the product. There is no need for a human being to be involved in the transaction. Smart contracts work in a very similar way.

Much like the vending machine, once the terms of the smart contract are met, it will automatically execute the terms of the agreement.

Since a smart contract is computer code, it can be programmed to serve any purpose. Currently, we are most frequently seeing them used to automate financial transactions, transfer of ownership, as well as managing data or assets.  As the technology continues to develop, we will likely see even more innovative uses for smart contracts.