Smart Contracts in a nutshell
QUICK TAKE: Origin, concept, benefits and relationship with principles of cryptoeconomics. Smart contracts are not “smart”, and do not always represent a legal contract.
Origin of the word “smart contracts”
The term “smart contract” was first used by Nick Szabo in 1997, in his text “Smart contracts: formalizing and securing relationship on public networks”, with the aim of bringing more evolved practices to electronic commerce protocols on the Internet.
Inspired by researchers such as David Chaum, Nick Szabo sought to improve relations between parties in online commerce by automating and making immutable their execution.
Smart Contracts are automated machines
Phone blocks by telecom providers, cars that incorporate speed limits are smart contracts, for example.
Smart contracts not based on Blockchain
Smart contracts appeared before Bitcoin — the first Blockchain.
But… blockchain technology has significantly expanded the quality and possibilities for using smart contracts.
But what are smart contracts anyway?
Smart contracts are software codes that incorporate governance rules and business logic within a Blockchain.
What do smart contracts bring us?
According to Nick Szabo, smart contracts bring:
- Transparency in transactions
- Disintermediation of third parties
- Automation in the execution of obligations
- impose penalties on those who violate contracting rules
- provide mechanisms to efficiently manage assets, tokens and access rights between two or more parties
Smart contracts are an “encrypted box”
Imagine an “encrypted box” that unlocks a value or an access right if and when certain pre-established conditions are met.
These values and access rights are stored on a blockchain, which protects them against deletion, tampering and fraud.
Smart contracts are not “smart”, and do not always represent a legal contract
A smart contract is a specific set of instructions that are executed in specific circumstances
They may or may not translate into a traditional legal contract.
Even if a smart contract is used to represent a “legal” contract, it is not possible to adopt smart contracts as a replacement for all traditional contracts, because not all provisions of law can be expressed with computer logic, and because it is impossible to replace traditional contracts in which the subjective component is a key component.
- The main difference between legal contracts and smart contracts
The main idea behind the concept of “smart contracts” is that certain types of contractual clauses (such as guarantees, delimitation of property rights, etc.) are incorporated into the hardware and software, so that their non-execution (if desired) is extremely expensive for the “infringer”.
In practice, they carry one of the principles of contemporary cryptoeconomics: the principle of self-enforcement. According to this principle, the violation of a smart contract must be prohibitively “expensive”.
Note that the principle of self-enforcement is diametrically opposed to the tradition of anthropological perspectives on traditional (legal) contracts.
This is because it is the possibility of breach and non-compliance that emerges as the critical distinction between smart contracts and conventional contracts — executed in natural language and subject to human performance.
What are the main advantages of smart contracts?
Smart contracts are revolutionary because:
- They reduce negotiation, verification and execution costs
- They provide greater transaction security than traditional contracts
- They enable real-time traceability of contract performance
Why are smart contracts more sophisticated on blockchains?
When implemented on a blockchain, the execution of a smart contract does not take place on a “centralized” server, but in a distributed, decentralized manner among the participants in the network
This is why, when “running” on a Blockchain, smart contracts are more sophisticated than traditional means of technological regulation, because they qualify as computer code that is “autonomous” (does not depend on a third party to operate) and is “independent” (cannot be controlled by third parties or anyone else).
Who can interact with smart contracts? And what are DAOs?
Smart contracts can interact with humans (natural or legal persons), or with other smart contracts within the same blockchain ecosystem — what is known as a Distributed Autonomous Organization — DAO.
Examples of smart contracts in the real world
LO3 has built an application that uses smart contracts and allows users of the electricity grid in the Brooklyn borough of New York to control their energy use, choose how much they want to spend on energy per day, and even trade the surplus energy produced by the solar panels installed on their homes with their neighbors.
Takeaway
As we can see, smart contracts are an additional tool to the “automation of trust” provided by Blockchains.
They can be used in practically all sectors and industries.
And while many smart contracts are easy to implement on a technical level (as they only require timestamps), from a regulatory point of view there can be some complexity and cultural resistance.
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