Smart contracts are like traditional contracts, but digital — they are programs that are written, stored and run on a decentralized ledger called the blockchain (such as Ethereum for example). Smart contracts are "self-executing" — meaning that they can be programmed to execute the terms of an agreement when certain conditions are met without the need for an intermediary to manage compliance or enforce the terms of the contract. It's similar to how a vending machine works; you insert money into the machine, press a button and receive your soda as a reward.
A smart contract is made up of two parts:
- Code (functions) — contains instructions for how your program should behave when certain conditions are met (e.g. "pay me $1 if x happens");
- Data (state) — contains information about what happened before it was executed (e.g. "I bought pizza at 2 pm today").
These two parts are stored together on the blockchain (which acts as a secure database for keeping track of all smart contracts). The code contained within a smart contract is executed by the network of computers on the blockchain network (called nodes). This means that they can't be tampered with, or changed by anyone. This makes smart contracts a good choice for transfer of some sort of value between two or more parties (based on rules that are strictly enforced and cannot be manipulated).
Smart contracts can offer you a lot of benefits over traditional contracts, such as:
- Flexibility & Efficiency — they can be programmed to perform any kind of business action (such as automating tasks and services) without the need for any third party oversight, mediation, delays or fees;
- Self-Execution & Speed — they're fast as they run automatically (and immediately) once certain conditions are met;
- Immutability — once a contract is created or executed, the blockchain is updated and no alterations can be made;
- Distributed Nature — the output of the contract is validated by everyone on the blockchain network, making it hard to tamper with;
- Security — the blockchain data is only accessible by parties who have been granted permission;
- Reliability — they make sure all parties involved (e.g. buyer, seller, bank, etc.) are bound by the terms of the contract;
- Verifiability — the code and the agreements of the contract, as well as the outcome of its execution, exists across the many distributed computers on the blockchain network, making the transactions secure, trackable and irreversible;
- Transparency — they provide audit, trust and visibility into complex processes (such as in supply-chain management).
All these points (and many more) make smart contracts a powerful tool for managing complex negotiations and agreements. For example, smart contracts can be used to exchange money, property, shares or anything of value.
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