Smart Contract 101

Smart Contracts are digital agreements residing on a blockchain (these agreements are on multiple computers, and can be seen by anyone who wants to see them). Every term of a contract is written using automated code, which means that there is no need for any third party or enforcement mechanism. As a result, even anonymous parties can enter into contracts in a secure manner. In this blog, we will cover the basics of a Smart Contract and how it differs from traditional contracts. 

Smart Contract 101 diagram

Simply put, a smart contract can be thought of as a more advanced form of the regular paper contract, where all the contents of the agreement have been converted into code. A small computer program saves every term and condition of the contract. This code cannot be modified later on, and therefore becomes law and automatically enforceable. 

The most common issue with a regular contract is that there is a chance that one of the parties might not fulfill their obligations. With a Smart Contract, every commitment is saved in the form of code which cannot be broken.

So, how does the code guarantee that no rules will be broken? The answer to this is quite simple – blockchain technology. 

Through blockchain technology, you can create an information chain that is immutable (unchangeable) and distributed (present on multiple computer systems). 

So, now, how do you ensure that this information remains unchanged? Here is how:

  • Block 0 will contain information on a handful of rules and transactions. 
  • Block 1 shall consist of a code based on the information present in Block 0 along with any other rules or transactions. 
  • Block 2, meanwhile, will have yet another piece of code, created on the basis of content present in Block 1. 

In other words, this chain will continue to grow, with every new block relying upon all the previous blocks. 

Now, say if you want to alter some information on block 8233, you cannot do it unless you go back and alter the information on all the previous 8,232 blocks. If you change block 8233 without rewriting the previous blocks, the chain will cease to make any sense, as it is essential that the contents on any block match the contents on all other blocks of the chain. 

To summarize:

  • We have a chain containing numerous little blocks, with each block dependent upon each other. 
  • This chain resides on numerous computers throughout the world.

How do the above two features ensure the creation of unbreakable contracts? 

For one, since the contract information will be present on many computers across the globe, it cannot be lost.  

Secondly, since the contents of the contract are present on the blockchain, they cannot be altered in any way. 

If that is not enough, a Smart Contract is a set of binding rules converted into code. You cannot interpret those rules in multiple ways, or take a different subjective approach. The program will operate a certain way and deliver a certain outcome depending upon certain requirements or conditions. In other words, there is no place for feelings, opinions, or thoughts. 

Smart Contract v/s Paper Contract:

Now that you know what Smart Contracts really are, let us see how they stack up against their traditional, paper counterparts:

  • A paper contract can get lost. A Smart Contract, as we just learned, cannot be lost
  • With paper contracts, there are costs associated with intermediaries (transactions costs and enforcement fees, for example). Blockchain, due to the absence of intermediaries, is cheaper
  • With paper contracts, there is a possibility of jurisdiction (which can lead to court and lawyer expenses). With Smart Contracts, no enforcement mechanisms are required
  • Parties entering into paper contracts can break obligations. Smart Contracts, on the other hand, are unbreakable and provide no room for fraud
  • Executing a paper contract can take several days or even weeks. Smart Contracts, meanwhile, are executed within seconds
  • Paper contracts, in most cases, cannot be reused. Smart Contracts, on the other hand, are reusable

Final Word:

To sum up, even though the term ‘smart’ seems rather fancy and sophisticated, a Smart Contract is simply a digitized form of a paper agreement. Having said that, a Smart Contract offers a number of distinct advantages, and for this reason, have become popular in a range of areas such as investment, real estate, and even divorce

We hope that this brief guide helped you grasp the fundamentals of Smart Contracts and how they differ from traditional paper contracts.