A smart contract is a self-executing contract with the terms of the agreement directly written into code. They exist across a decentralized blockchain network and automatically execute transactions when predetermined conditions are met, without the need for an intermediary. This code not only defines the rules and penalties around an agreement in the same way a traditional contract does, but it can also automatically enforce those obligations.
Smart contracts were first proposed in 1994 by Nick Szabo, an American computer scientist and cryptographer, but they didn’t become a reality until the development of blockchain technology. The most widespread application of smart contracts is in the Ethereum blockchain, but many other cryptocurrencies and blockchain platforms also support them.
The major benefits of smart contracts include:
- Trust: Since the contract is automated and transactions are transparent and traceable, parties don’t need to trust each other, just the code.
- Security: Being stored on a blockchain, they are encrypted and distributed among nodes. This makes them nearly impossible to hack.
- Efficiency and Speed: Automated contracts eliminate the need for intermediaries and reduce time spent on paperwork.
- Cost Reduction: By removing the need for intermediaries or a third party, smart contracts can also greatly reduce costs associated with those services.
However, they’re not without their challenges, such as legal recognition and handling situations that haven’t been predefined in the code. There’s also the risk of bugs in the code, which could have serious implications due to the immutable nature of blockchain technology.
It’s important to note that as a smart contract is a piece of code, it can only control digital assets and resources. For it to interact with the real world, a reliable and trustworthy source of information, often referred to as an “oracle”, must be used.