A contract is a signed agreement between two parties with a third party that stands between two parties who are making a transaction and affirming the terms and conditions of a contract. This way is typically characterized by the traditional centralized system. Oftentimes, these paper contracts have brought about discord and legal conflicts amongst business partners. This discord is as a result of different things such as serious oversights as a result of communication breakdown, breach of contract, contracts not properly drafted, etc. Sometimes, these contracts are susceptible to forgery from either of the parties. However, there have been steps to restructure business contracts and one of the best alternatives to the traditional model is the smart contract.
Nick Szabo, an American computer scientist, and cryptographer, first proposed smart contracts in 1994. He invented a virtual currency called “Bit Gold” in 1998, ten years before the invention of Bitcoin. At some point, he was rumored to be the real Satoshi Nakamoto, anonymous inventor of Bitcoin, which he has often denied.
According to Szabo, smart contracts are computerized transaction protocols that execute terms of a contract. He realized that blockchain, the distributed ledger, could be used for smart contracts, which are otherwise called self-executive contracts, blockchain contracts, or digital contracts.
A smart contract is a software that digitally stores rules for negotiating the terms of an agreement, automatically verifies fulfillment, and executes the agreed terms. It is a self-executing contract with the terms of the agreement between two parties directly written into lines of code. The code and the agreement contained therein exist across a distributed, decentralized blockchain network. A smart contract allows the performance of credible transactions without third parties. A smart contract renders a transaction transparent, traceable, and irreversible.
Ethereum is the most popular cryptocurrency that uses the smart contract. Bitcoin, on the other hand, permits using smart contracts to build services and add functionality on top of bitcoin transactions. Although these services us bitcoin, they are inherently centralized because their smart contracts must be hosted on a centralized server. Ethereum, however, lets developers program their own smart contracts to define Ethereum Virtual Machines (EVM) instructions. An example using an automated flight insurance smart contract that uses an oracle to look up data about flight delays will be used to explain how smart contracts work.
The first step is that a passenger asks for flight insurance by sending ethers to a smart contract, along with her flight information. The smart contract, in turn, sends a request to an “oracle”, which is a service that exists outside the blockchain, to verify the flight details and gather historical information about that route.
The smart contract uses the information to determine if the offered premium is adequate; if the smart contract accepts the premium, it then goes ahead to ask the oracle if the report on the status of the flight in question. The information provided by RealTimeFlightData is used by the oracle to report the status of the flight to the smart contract. If the flight is delayed, the contract pays the passenger; if the flight on time, the contract pays itself.
Third-Party Involvement – In a traditional contract, there are two parties to sign a contract and a third person. This third person could be a barrister or bank. This encourages back and forth drafting phases and the final administration of the finalized agreement takes a lot of time. The smart contract, on the other hand, performs credible transactions without the presence of third-parties, which makes it faster and more reliable.
Lack of human element – The traditional contract requires the physical presence of all parties related to the contract. The smart contract, however, is computer-generated and thus, the code itself explains the obligations to both parties. Parties involved in the smart contract are most times, strangers from the internet who have never met before. Smart contract can also reduce the friction that is common in settlement financing. Since the process is automated, all the necessary steps would have been logged, verified, and implemented on the blockchain, removing the need for dispute resolution. The goal of the smart contract is to facilitate business arrangement without the unnecessary formality and cost.
Forgery – One of the issues the traditional contract has, is that it is prone to forgery. With the presence of the human elements, either of the parties goes behind to alter what was agreed upon by both parties, and this has caused serious legal battles that dragged in courts for several weeks. The smart contract carries out its transactions that are transparent, traceable, and irreversible.
Unlike the traditional contracts, the smart contract’s communication is very explicit and the detailing accurate, thereby eliminating any room for miscommunication and misinterpretation.
All relevant parties can view, at any time, the terms and conditions of the contract. This way, discord does not arise and it facilitates total control and transparency to all concerned parties.
One of the things that make the smart contract unique, is its attention to details. One of the primary requirements is to record all terms and conditions in explicit details. It is important to be accurate, because a mistake could result in transaction errors.
The smart contracts run on software code and live on the internet. Because of this, transaction can be done very quickly. The elimination of intermediaries and prolonged court cases also help to shave hours off many traditional business processes. Also, there is no manual documentation.
With the way smart contracts operate, they generate trust and absolute confident. This is because it is transparent, removes the possibility of manipulation, it is secure, and autonomous. Once solemnized, the contract is executed automatically by the network.
One of the major advantages of smart contracts, is that it is paper free. Without the use of paper contracts, smart contracts greatly eliminate fraud or forged documents, and in the event of a data loss, these attributes are easily retrievable.