Most people have encountered the term “smart contract” at least once, often in relation to decentralized applications (dApps). But why exactly have smart contracts completely revolutionized the world of finance and modern business? Let’s dive in.
The first person to talk about smart contracts was Nick Szabo, a cryptographer, back in the 1990s. Many also attribute to him contributions related to the creation of Bitcoin.
Nick Szabo described smart contracts as a set of digitally recorded protocols and agreements that help participants follow through on these agreements. His goal was to find a method that would allow contracts to be concluded purely in digital form.
Smart contracts found excellent application in the world of cryptocurrencies. They are considered among the fastest, most anonymous, cost-effective, and secure methods — key qualities for financial transactions. However, for these very reasons, banks and governments around the world are not particularly fond of them.
How it works
A vending machine provides a good analogy for how smart contracts operate. We all know that shopping in a store typically involves extra costs, which are included in the price of goods. However, if we deposit money into a vending machine, we can get the desired product without needing a salesperson. This way, we avoid the service charge because there’s no need to pay a person to hand us the product. Here, all money-related and product delivery actions are carried out by the machine — much like a smart contract.
A smart contract defines behavioral rules for the parties involved and ensures these rules are enforced. In other words, a smart contract transforms a virtual asset into a program. This program includes code that, based on set conditions, determines when and how the asset should be transferred to its owner or another party. This approach helps save time and ensures both parties adhere to the agreement.
Ethereum is a popular blockchain that implemented the principle of smart contracts — and it’s far from the only one!