A smart contract is a self-executing contract with the terms of the agreement between the buyer and seller written directly into lines of code. Smart contracts allow trusted transactions and agreements to be executed between disparate and anonymous parties without the need for a central authority, legal system, or external enforcement monitoring mechanism.
Smart contracts were first proposed in 1994 by Nick Szabo, an American computer scientist who invented a virtual currency called Bit Gold in 1998, a full 10 years before Bitcoin was invented.
Smart contracts are computer protocols that digitally facilitate the verification, control or enforcement of an agreement. Similar to traditional contracts, smart contracts define rules and penalties around the agreement and automatically enforce these obligations. While they can operate independently, many smart contracts can also be executed together.
There are three basic components of a smart contract:
- signatories, which are the parties involved in smart contracts that use digital signatures to agree to or reject contractual terms;
- the subject matter of the agreement or contract;
- specific terms.
Smart contracts can be used in a variety of fields:
- The government voting system: smart contracts provide a secure environment that makes the voting system less vulnerable to manipulation. Votes using smart contracts will be protected by a ledger, which is very difficult to decipher.
- Health care: the blockchain can store encrypted health records of patients using a private key.
- Supply chains: the blockchain can negate these risks by offering an accessible and secure digital copy to the parties involved in the chain. Smart contracts can also be used to manage inventory and automate payments and tasks.
- Financial services: smart contracts are helping to transform traditional financial services in multiple ways. In the case of insurance claims, they check for errors, direct payments and transfer them to the user if they find everything appropriate.
Benefits of smart contracts:
- Autonomy and savings: smart contracts do not need brokers or other intermediaries to confirm the agreement.
- Backup: all documents stored on the blockchain are duplicated multiple times, thus, the originals can be restored if any data is lost.
- Safety: smart contracts are encrypted.
- Speed: smart contracts automate tasks using computer protocols, saving hours of various business operations.
- Accuracy: the use of smart contracts eliminates errors caused by manual filling of many forms.
Limits of smart contracts:
- Difficult to change: altering smart contract operations is nearly impossible.
- Possibility of loopholes: the use of smart contracts makes it difficult to ensure that the conditions of the deal are met as agreed.
- Third parties: for example, lawyers will not be required to prepare individual contracts, however, developers will need to understand the terms of creating code for smart contracts.
- Ambiguous Terms: since contracts always include understandable terms, smart contracts are not always able to handle ambiguous and complex terms and conditions.
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