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What Are Smart Contracts and Why You Need to Know About Them

By May 11, 2021March 23rd, 20225 minute read

This is written by an external blogger, the views and opinions expressed within the post belong solely to the author

One of the most talked about topics to come out of the surge in popularity of DeFi is Smart Contracts, but not a lot of people really understand what they are and what they can mean for us. In this article, we aim to explain exactly what smart contracts are, and what the technology is capable of doing. 

The term was first coined by the computer scientist Nick Szabo in his paper titled ‘Smart Contracts: Building Blocks for Digital Markets’ published in 1994. Yes, 27 years ago. In 1996, Szabo described smart contracts as “a set of promises, specified in digital form, including protocols within which the parties perform on these promises.” While the technology available to support smart contracts has evolved considerably since then, in essence, that’s what smart contracts are and do. Let’s explore what that definition means for us in the real world.

The significance of contracts in our current systems

In terms of contract law, a contract is a promise or performance given in exchange for a promise or performance. In simple terms, it is situations like “I will give you 10,000 rupees if you deliver the mobile phone I want to my house”, or “I will deliver the mobile phone you want to your house if you give me 10,000 rupees”. One is a promise in exchange for performing an act, and the other is the performance of an act in exchange for a promise. 

These types of exchanges are absolutely everywhere in our current systems. If you pay rent, you have a contract. If you have an internet connection at home, it’s a contract. Same with nearly every transaction that we take part in. They serve as a record for commitment from both parties, help prevent conflicts and mitigate risks, and are a foundation stone for our civilisation as we know it today. These agreements are what allow us to work collectively towards achieving all the great things that humanity has achieved. 

Contracts can be written or verbal, however, they are only meaningful if there is a way to enforce them, or prevent someone from breaking their promise. That job is done by our legal systems in the form of all of the provisions we have in case someone breaches a contract. So in that sense, a traditional contract is between three parties, the promisor, the promisee, and the state. 

These systems still come with their fair share of problems, however. Cost, the amount of time it takes, enforcement, transparency, and conflict of interest are some of the areas where there’s a big potential for improvement.

How smart contracts can change the way we look at these agreements

Smart contracts use programming and computer code to automatically execute the agreement when the given conditions are met, without the need for human intervention. Normally, while executing agreements involving various stakeholders, a third party (like a lawyer) would be needed to scrutinize and verify all the information making it a complex and time-consuming process. Smart contracts simplify it by eliminating the third party and automating the process, enabling stakeholders to transact with each other directly. This improves the cost and time efficiency of our current systems to a great extent.

Some contracts also have a conflict of interest between the promisee and the promisor. Taking the example of insurance, the interests of a for-profit insurance company are the opposite of the interests of the insured. The company has all the motivation to not follow through to the contract and the insured has to trust the company to follow through with their promise. Smart contracts automate the process of following through once the pre-decided conditions are met. Since smart contracts are built on blockchain and cannot be edited once they’re deployed, they are transparent and public. 

People in some countries with highly developed legal systems can almost take the enforcement aspect of contracts for granted. However, in other developing countries, the ground reality is different. The legal systems are overburdened, understaffed, and are generally less robust. In some cases, like in the case of health insurance, the time it takes to obtain legal recourse could prove to be fatal. Smart contracts can automate a lot of the excessive work of the legal system while still following the laws of the land, reducing a huge amount of burden and ensuring many more people can get justice.

Other use cases for smart contracts

Future use cases for smart contracts are only limited by our imagination. From making a common enforcement infrastructure for an individual in Kenya transacting with an individual in Canada, to automating basic everyday transactions and agreements. The most commonly given example for a smart contract system that exists right now is a vending machine. It automates the process of buying an item while eliminating the middleman, or a shopkeeper. Some other cases where smart contracts can improve our systems with existing technology are – 

Banking and financial services – trust is paramount in traditional banking and financial services, and the sector is riddled with intermediaries whose interests do not always align with those of the customers. Numerous examples can be given for this, but the great rise in popularity of decentralized finance, or DeFi, proves that people see value in trustless financial services. 

Digital identity – in the increasingly digitised world that we live in today, digital identity misuse and theft is a very real problem. Companies like Google, Facebook, Amazon, etc have an incredible amount of data on their users, which the users have to trust the companies not to misuse. Leaks and hacks still happen though, like the recent massive data leak from Facebook that affected over 500 million people. Smart contracts would enable people to own and control their personal data, and reduce the liability for companies that have to safeguard massive amounts of data.

Supply chain management – most companies in our globalized world have extremely complicated, multi-party supply chains. Companies also find it challenging to keep their supply chains proprietary since so many parties are involved. Using smart contracts to simplify supply chains and using Internet of Things devices to provide greater visibility and security for supply chains is one of the most anticipated use cases. 

Healthcare – Better data sharing between healthcare providers means a higher probability of accurate diagnoses, more effective treatments, and the overall increased ability of healthcare organizations to deliver cost-effective care. Smart contracts can allow various stakeholders in the healthcare value-chain to share access to their networks without compromising data security and integrity, by allowing them to track data provenance as well as any changes made.

Not every day does new technology come along that has the potential to change not one or two industries, but to change the entire way we conduct business in our society. Only time can tell whether the potential would be realised or not, but till then, it’s best to get ourselves up to speed with the new developments.

About Guest Blogger (Parv)

Parv is a blockchain and cryptocurrency researcher, trader, and consultant with years of experience within the industry. When he isn’t occupied with crypto, he enjoys reading, traveling the world, and meeting new people. Check out his blog posts here
Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
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