What is a Smart Contract?

Most people still equate Bitcoin with Cryptocurrencies and Blockchains in general. What is the point of all the others? Perhaps the best place to start understanding why, to some minds, the potential of Crypto goes beyond Bitcoin alone is “smart contracts”.

Smart contracts are an agreement which is written into computer code which is contained on a blockchain. This is important because it means that the content of the contract cannot be altered, obstructed, or otherwise tampered with by any one actor. That is to say, smart contracts are decentralized when they are “Blockchained”. In this respect, they resemble that important feature of Bitcoin as a decentralized store of value.

This decentralized code contains the terms of the agreement and is self-executing or automatic. This means that the contract will specify some specific event(s) that will trigger the contract’s terms. So, if and when defined event-A happens, then consequence-B which the contract stipulates will also happen.

Amongst other things, smart contracts offer so much potential because of the potential efficiencies it generates, reducing the need for “middlemen”. Another virtue is trust. Decentralized smart contracts don’t depend on the parties having trust in any one particular central institution meeting their obligations because smart contracts are self-executing.

Finance is the area in which most existing projects in the crypto arena reside, giving rise to the “defi” term you might have come across. But to illustrate smart contracts we give one straightforward example from a different arena. Imagine a flood insurance smart contract, in which a payment is triggered when, say, the river-level in a specified place exceeds some specified-level. That payment could, in principle, be instantaneous and with full trust on the insured party’s side that they would receive their payment if that event occurs.

Smart contracts were identified as a theoretical possibility in the 1990s by Nick Szabo. A number of projects have since emerged that seek to realize this potential. Ethereum is, by a clear margin, the main project that enables smart contracts. For this reason, Ethereum might very well have been the second Crypto you heard of after Bitcoin. But there are others. Moreover, many of the use-cases for smart contracts will only ever be as reliable as the data fed into them. This raises the issue of “oracles”, discussed in another piece.