What Exactly Is a Smart Contract

Smart Contract: Blockchains, the technology that underpins cryptocurrencies such as Bitcoin, are decentralized ledgers maintained by a trustworthy source that tracks who owns what. Long after the Bitcoin frenzy has subsided and the currency has returned to “normal” levels, Blockchains are likely to persist and could underpin much of the high-value transaction processing that is currently limited to banks.

Blockchains address some of the most pressing issues surrounding internet transactions. They are difficult to hack because they store information securely on multiple computers at the same time. 

Because they are decentralized, there are no middlemen taking a cut simply because they own the only machine capable of conducting it. As it stands, the system is far from perfect, but it shows promise.

Blockchains also provide features that traditional processing technology does not. Smart contracts are the most useful of these.

Smart contracts can sit within Blockchains

Smart contracts are also referred to as ‘Self Executing Contracts.’ Because blockchains are electronic in nature, they can be programmed with logic. Smart contracts are conditional terms that can be stored in multiple ledgers at the same time as a set of rules and will perform their function automatically.

Because multiple Blockchains can exist, each storing different types and types of information, we may end up with a number of them, each backed by institutions we trust (for example, the government) and combining to execute these smart contract agreements.

An example of how smart contracts might work in real life

Here’s an example of how a smart contract might function in this type of setting.

Consider purchasing your prepaid plan at your local supermarket. You tell the cashier what you want. He or she accepts your money, presses a few keys, verifies your identity with a driver’s license, and hands over your prepaid pack.

Consider the same transaction in a world where there are multiple Blockchains. Assume the US government has released a Blockchain and is now using it to verify citizens’ identities. 

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This USA Blockchain is backed by the administration and contains information such as your social security number, birth certificate, driver’s license, and if you’re married, a marriage certificate.

For the purposes of this example, you want to purchase a prepaid plan, so you use your mobile phone to fill out a form on the AT&T website.

The smart contract in the Blockchain behind the website simply waits indefinitely, as computers do, until you provide two things.

First, make a $20 payment (the cost of the prepaid plan you’re purchasing). To pay for this part of the transaction, you use a portion of your Bitcoin balance that is stored in the Blockchain.

Second, you must present your ID for verification. The AT&T Blockchain communicates with the government Blockchain, which confirms your ID for this purpose because you have authorized it.

The procedure has remained unchanged. However, the variables involved are now provided only once to a Blockchain, which is issued by a trusted source and securely stores them until you need them. A cashier at a supermarket is no longer involved in the process. The transaction is carried out by the Blockchain itself, which issues the prepaid SIM pack when the necessary conditions are met – in this case, when ID is provided and payment is made. The Blockchain contains the logic for the entire system. You may have also noticed that no bank was involved at all.

Why do we need Smart Contracts?

Smart contracts are simple to create and manage, have no middlemen, and are therefore less expensive and more efficient than the delays in payment processing that banks currently impose. They’re also not a pipe dream. Ripple, the world’s largest Blockchain, is currently valued at $20 billion and can conduct smart contract agreements.

However, as previously stated, Blockchains in their current form are not perfect. The cost of electricity to conduct Blockchain transactions is increasing exponentially. Some estimates place the cost of electricity at around $150 USD (although power prices vary around the world, 15c / KWh is a representative cost, and it currently consumes 1000 KWh to transact over a blockchain). 

That means that, while the prepaid example exemplifies the concept, it is far more likely that Blockchains and smart contracts will be used in major transactions such as the purchase of a home.

Blockchains are of great interest to banks, governments, and other organizations that issue critical, identity-related information that is used repeatedly. They, along with smart contracts, are likely to be the foundation of future financial infrastructure.