Understanding: smart contracts (blockchain and smart contracts)

The smart contract converts an agreement between two parties into computer code, but unlike the traditional contract, in addition to defining the rules and penalties related to the agreement, it can automatically apply these obligations.

The smarts contracts, which are based on blockchain, have the potential to blow industries such as legal and finance by simplifying and automating routine and repetitive processes where people currently pay large fees to lawyers and banks.

To understand this technology, we must first look to traditional contracts to compare their operation.

The traditional contract

A traditional contract is an agreement or an agreement between two or more parties to do certain things. It is a written set of conditions and actions to be performed, which requires human validation to verify terms and conditions and decide on next steps. Since the written contract is not unambiguous, different parties may have a different interpretation of the contract. Hence the intervention of a qualified third party 'trust' to apply the law.

The execution of a traditional 'paper' contract has limitations:

Liabilities - Whenever a contract is to be executed, one party handles the paperwork internally and sends it to the other party to check the paperwork and respond accordingly to the original party.

Asymmetric Information - It is difficult for both parties to have the same data to create a fair contract. Not to mention that most of the time, it will miss data.

Ineffective - A contract must be verified, validated and approved, the next steps must be activated, etc.

Costly - The involvement of a third party consumes time and resources.

User error and fraud - Even if the above points are resolved, this does not neglect the possibility for a party to break the contract.

The smart contract

Because smart contracts exist in the blockchain, it is possible to program codes that run automatically without the need for intermediaries.

For example, a smart contract provides for a payment at the end of a transaction. The code is loaded into the blockchain as a transaction in a new block. It waits for the signal to execute based on the result. And when the smart contract receives the signal, it will automatically execute to send the money

The smart contract solves some limitations of the traditional contract:

Active execution - Once both parties have agreed that there are several conditions, the smart contract automatically executes the codes and no one can stop the process.

Full Record and Available Data - Records and data origins are all stored in the blockchain, eliminating asymmetric information.

Effective - The code runs in seconds and sends the money immediately.

Reduced Fees - There is no paperwork or third party involved.

Eliminate user errors - Smart contracts eliminate user facilitation to a minimum, reducing errors and fraud.

The potential of smarts contracts goes beyond the simple transfer of assets, there can be several smart contracts linked to each other to provide public services to other contracts. The same principle applies to real-world scenarios, sectors such as medical records, logistics, finance, insurance and IoT can benefit from smart contracts to eliminate third parties.