A client (for this narrative I will call him Igor) from a central Russia region breathlessly phoned me after this past Thanksgiving weekend to say he was in Moscow and urgently needed to meet. My mercantile brain kicked into gear, and we agreed to lunch at a fine restaurant on Tverskaya Street. To make a long story short, he had a board meeting two days earlier and was “ordered” to get the company geared up to employ blockchain smart contract applications to reduce overheads and improve efficiencies – immediately.
I felt for him, as this was a fork-in-the-road situation that can make or break careers in the structured corporate world. There are few if any second chances, especially in the classical Russian cultural mindset. Before we even got to the appetizers, he bared his soul to me…. “What in the hell are smart contracts? How can any contract be smart, isn’t that why we have our lawyers?” Bottom line, I tried to explain to him what smart contracts were, which was an exercise in itself as I am (as he is) a self-confessed analog newbie in the digital world.
Not long ago I wrote an opinion piece of my first experience in being paid with crypto-currency. I therefore hoped my very basic overview was not too confused or unclear, especially when charging several ETH’s for this consulting luncheon explanation attempt.
The concept of a smart contract is not new; in fact, it predates what today we call the “blockchain” in the IoT (internet of things). In 1996, more than 20 years ago, computer scientist Nick Szabo wrote; “A smart contract is a set of promises, specified in digital form, including protocols within which the parties perform on the other promises. The basic idea of smart contracts is that many kinds of contractual clauses (such as liens, bonding, delineation of property rights, etc.) can be embedded in the hardware and software we deal with, in such a way as to make breach of contract expensive (if desired, sometimes prohibitively so) for the breacher.”
More recently in 2014, Vitalik Buterin the founder of Etherium stated: “A smart contract is a mechanism involving digital assets and two or more parties, where some or all of the parties put assets in, and assets are automatically redistributed among those parties according to a formula based on certain data that is not known at the time the contract is initiated.”
For example, two persons have a 1 ETH wager and decide to settle it through a smart contract. One says that on December 25, 2018 at 1400 hours local time the temperature in central Moscow city will be lower than minus 20 degrees Celsius, the other says it shall be above. A smart contract is programmed with the given parameters, both parties enter their relevant e-wallet addresses, the sum at stake and electronically seal the deal via an agreed upon “oracle” (more on this later).
Automatically on December 25that 1400 hours, the programmed smart contract autonomously gets the needed temperature input from the Moscow meteorological service and the 1 ETH is immediately debited from the loser’s wallet, and credited to the winner’s wallet. After the initial programming and agreement, it became an autonomous function fully embedded and operational on the blockchain ledger.
Therefore, what is a smart Contract? A “smart contract” is a set of coded computer functions. It may incorporate the elements of a binding contract (e.g., offer, acceptance, and consideration), or may simply execute certain terms of a contract like the above wager. It permits self-executing computer code to take actions at specified times and/or based on reference to an action or the absence of an action or event (e.g., delivery of an asset, weather conditions, or change in a reference rate).
What is so smart about a smart contract? This is what leads to some confusion, as a “smart contract” is not necessarily “smart.” The functional operation is only as smart as the information feed it receives and the machine code that directs it. In various jurisdictions, a “smart contract” may not (yet) be a legally binding contract. It may also be only part or subset of a broader contract, depending on your wishes and instruction.
Smart contracts use digital signatures – private cryptographic keys held by each party to verify participation and assent to agreed terms. Smart contracts use “oracles” – a mutually agreed upon, network- authenticated reference data provider (potentially a third-party); this is a source of information to determine actions and/or contractual outcomes, for example, commodity prices, weather data, interest rates, or an event occurrence. A smart contract can self-execute, it will take actions, e.g., disperse payments, without further action by the counterparties. Smart contracts can be stored and executed on a distributed ledger (blockchain), an electronic record that is updated in real-time and maintained on geographically dispersed servers or nodes. Through decentralization, evidence of the smart contract is deployed to allnodes on a network, which effectively prevents modifications not authorized or agreed by the parties.
Blockchain is a continuously growing database of permanent records, “blocks,” which are linked and secured using cryptography.
Smart contracts are part of an evolution to automate processes with machines and self-executing code. Examples of varying degrees of complexity are seen daily as automation further embeds in daily life, such as ATM’s, Automatic bill paying, Touch-to-pay systems, instant money transfer apps, and so forth.
Smart Contracts will see growing uses in financial market operations, and likewise may be useful in a variety of other areas as well. Examples include automated payouts of dividends, stock splits, tracking product movement, streamline payments, facilitate lending and liquidity.
Read Paul’s article in full here.