By
Austin Tuwiner Sam Klemens • April 29th, 2020

What are Smart Contracts? A Beginners Guide

A smart contract is a contract created and maintained on a blockchain platform. Smart contracts execute automatically, based on a pre-defined set of criteria. They do not require a third party.

Because of this autonomy smart contracts are extremely secure and fraud-resistant. They operate on a series of if-then scenarios which are known to all parties before they enter into the contract.

Key Points

  • Perhaps the single greatest feature of a smart contract is that it doesn’t require trust in a third party. Smart contracts can even custody funds so that the chances of fraud are significantly reduced.
  • Smart contracts are a new technology and as such they are far from perfect. Bugs in the code are common and untold millions of dollars have been lost from poorly written smart contracts.
  • Currently Ethereum is the largest smart contract platform, however, that could change in the future as there are many projects vying for this top spot.

The Advantages of a Smart Contract

A smart contract can automate a lot of what is now done manually. Here is an example: global shipping. A shipping company can create a smart contract with the following parameters,

  • The contract must be funded with the full payment for shipping costs before the merchandise is picked up from China
  • As the merchandise is being shipping from China to the USA the funds remain in custody in a smart contract. Neither the buyer nor the shipping agent has access to them
  • The shipping agent delivers the merchandise to Los Angeles. The port scans the merchandise and uploads a confirmation to the smart contract which confirms the receipt of the merchandise and releases the funds to the shipping company.

As we can see in this example, the shipping company can see that the funds are in escrow so they don’t have to worry about not getting paid. When the merchandise reaches the USA their payment is immediately released, instead of being sent thirty to sixty days later as is common now.

That’s the benefit of the shipping company. For the buyer there is also an advantage, the smart contract automates functions that previously required accountants, bean pushers, secretaries, bankers, lawyers, etc. Thus they can save money on staffing by using a smart contract.

Another advantage of the smart contract is that it’s fully transparent. All parties can see the exact terms of the contract before they agree to it. This is similar to a normal contract, except that with a smart contract there is a guarantee that the contract will execute according to its parameters. There cannot be a breach of contract.

Finally, a well-written smart contract is very difficult to hack. Funds stored in a smart contract are just as safe as they would be in a bank vault. The terms of the contract cannot be changed and even if they were, there would be a record of that change left on the blockchain. With a smart contract, fraud becomes much, much more difficult.

The Disadvantages of a Smart Contract

The primary disadvantage of a smart contract is that it’s a relatively new technology and not well-understood by many people. Assuming they don’t already have in-house counsel it would take any company about fourteen seconds to find a lawyer who could draw up a contract.

Finding a good smart contract programmer is not nearly so simple. Blockchain programming is in huge demand right now and the best programmers demand high salaries.

Subpar programmers are more affordable, however, it’s a bit of a deal with the devil as even a small bug in the contract can lead to a catastrophic outcome. Tens of millions of dollars’ worth of funds (if not more) have been lost due to poorly coded smart contracts.

That loss is the result of both susceptibilities to hacks as well as funds lost due to internal logic errors. In five years there will be a whole new generation of smart contract programmers and the technology will be much more well understood. Today, however, unless you can hire an industry-leading smart contract programmer there will always be the risk of the contract failing.

One other disadvantage is that there is an overall lack of clear regulation regarding smart contracts. For example, if there is a problem then how will a smart contract be treated in a court of law?

Does it have the same legal standing as a traditional contract? What happens if the case appears before a judge who has never even heard of Bitcoin, let alone a smart contract? Until there is more regulatory and legal clarity, smart contracts are limited in terms of how they can be used.

Examples of a Smart Contract

A smart contract isn’t just a contract between two parties, it’s also a contract that can automate a function. For example, a blockchain-based decentralized exchange like Uniswap is actually just a fancy smart contact. The same for Maker DAO, the protocol behind the DAI stable coin. Smart contracts are incredibly versatile and allow for all sorts of interesting blockchain applications.

Popular Smart Contract Platforms

There are dozens of smart contract platforms in the blockchain ecosystem. Cardano has been in the news a lot recently with a recent upgrade to their system.

Cardano’s founder, Charles Hoskinson, claims that Cardano now has the potential to become more valuable than Bitcoin. If nothing else you can’t fault the project for a lack of aspiration. NEO, which has not been in the news, is a smart contract platform that focuses on the Chinese market.

By far the most popular smart contract platform is Ethereum, the world’s second most valuable cryptocurrency after Bitcoin. Ethereum is the originator of the smart contract and has by far the largest developer community and smart contract activity.

If their staking and scaling upgrades can be pulled off it’s almost hard to estimate how valuable the platform could become. That being said, there is still a lot of uncertainty regarding Ethereum and only time will tell how everything works out.

Austin Tuwiner Administrator
Austin is the owner of Bitpremier, and got involved in Bitcoin in 2012. After working as a cryptocurrency journalist and and at several blockchain startups, he decided to start Bitpremier and educate the world on Bitcoin.
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