Blockchain 101: What is a Smart Contract?
Remember “Blockchain technology represents a potential 3%-10% cost savings on every transaction that uses it as a medium of exchange”
A smart contract is a computer program that automatically executes when pre-agreed parameters are met. To execute you don’t need to trust that the other actor will come through on their side of the contract. You just need to trust the code. This sounds very confusing but bear with me. A basic smart contract could be something such as this: You and I could agree to a bet on the Seahawks, 49ers game. We must agree upon some third party (centralized now but potentially distributed in the future) who will confirm the true outcome of this bet, perhaps a 3rd party that scrapes ESPN’s API for the outcome of the game. In this hypothetical, we both will pay $100 worth of cryptocurrency into a smart contract. The contract itself holds the collateral in escrow until the parameters are fulfilled. As soon as the game is finished, and the Seahawks win, the third party will acknowledge this and the game contract will be settled right then and there. I, being the Seahawks fan, will receive $200 worth of cryptocurrency from the contract. The processing fee for executing the entire contract is minimal.
This may sound just like a novel experiment but there are a few reasons that make it game changing. The first reason is it can drastically decrease the costs of escrow and payments associated with escrow. Escrow costs are massive for transactions as expansive as global international trade and things as small as real estate transactions. For example, in real estate, 1% of the total transaction cost is usually given to the escrow company. This company’s only function is to safely hold the funds on one side and the deed on the other. Usually for less than 7 days. This is a massive inefficiency that will easily be removed when smart contract based systems are capable of fulfilling this scenario. The second major reason that smart contract technology will be revolutionary is that it will allow for new ways to organize how information, value, and rules interact. Smart contracts can facilitate structuring new kinds of organizations. Different types of Decentralized Autonomous Organizations (DAOs) are already popping up in a few different industries (See RLoop, Digix DAO, DASH). These structures of governance are starting to be explored and have yielded very promising preliminary results. In a future article I will dissect DAOs as they are deserving of their own post.
The largest and most highly renowned smart contract platform is Ethereum. Ethereum is the first smart contract platform to achieve large scale adoption by 3rd-party developers (the popular CryptoKitties collectibles game was an early example of an application run through smart contracts on the Ethereum blockchain). The native cryptocurrency of the Ethereum blockchain, Ether, is the second largest cryptocurrency by market capitalization. Ethereum has one of the largest developer bases in the industry. Developers are creating Decentralized Apps (DApps) on top of the platform to assist with the creation and execution of smart contracts. You can check out a full list of DApps at https://www.stateofthedapps.com/.
To recap, a smart contract is a piece of code that automatically executes a function when conditions that were previously agreed to are met. They promise to lower business costs significantly in many areas. A new type of governance system can easily be built out upon sets of smart contracts. This governance system has the potential to be highly efficient compared to legacy systems. They could disrupt the way both governments and companies are run.
P.S. If I were doing a dissertation for a doctorate, I would marry the death of democracy as we know it with the rise of DAOs.