What are smart contracts? Everything you need to know

Smart contract
(Image credit: Shutterstock / Visual Generation)

Blockchain technology is often solely associated with cryptocurrencies like Bitcoin, and for the first generation of blockchains, this was true. The technology underpinning Bitcoin was built solely as a payments processor, allowing participants to send and receive the digital currency, nothing more. However, blockchain has evolved two more generations since then, and ‘second generation’ blockchains like Ethereum came with several game-changing capabilities. Developers could build blockchain-based applications, raise funds for their projects through initial coin offerings (ICOs) and, most importantly, build smart contracts. 

Smart contracts essentially do what they say on the tin. They are digital contracts which are “smart” enough to automatically trigger when the terms of their associated agreement are fulfilled. While this sounds simple, this technology has the potential to completely transform the way business is carried out across the globe. The contracts remove the need for a middleman - such as a bank or legal representative, in transactions and agreements by using blockchain technology.  The contracts and terms of agreement are written directly into lines of code, and will self-execute once these criteria are fulfilled.  Because the code and corresponding agreements are held on a distributed, decentralized blockchain network, they don’t need to be held by a central party in an agreement, and transactions are trackable and irreversible.

About the author

Aparna Jue is Product Director at IOHK

What are the benefits?

Removing the need for a middleman has a huge range of benefits for businesses and consumers alike. It not only reduces costs by removing the often extortionate fees from third parties like notaries, estate agents or advisors, but also saves the time and resource normally wasted on manually processing or transporting paper documents. This means that many costly and inefficient business processes can be automated, removing any chance of human error and massively reducing the cost of doing business.

Crucially the contracts also remove the need for trust, as having a central, constantly updating version of the contract means that neither party can manipulate, steal or lose any documents. When implemented correctly, smart contracts are also extremely difficult to hack, meaning documents will be kept completely safe.

How can they be used?

These benefits have applications across nearly every industry when it comes to improving the speed and security of record-keeping. Take healthcare for example. Currently, the world‘s healthcare computer systems store huge amounts of patient medical records. Despite healthcare organizations beginning to invest more in security, they are still vulnerable to cyberattacks, as shown by the 2017 “WannaCry” NHS hack, in the UK, which saw 19,500 medical appointments cancelled, computers at 600 GP surgeries locked and five hospitals having to divert ambulances elsewhere. 

Blockchain technology could ensure these hacks are a thing of the past by allowing entire databases of personal health records to be securely encrypted and stored. By implementing smart contracts, things like prescriptions can also be automatically filled, saving valuable admin time and streamlining the patient experience. Taken one step further, the technology could also put control of health records back in the hands of the patients, allowing them to decide who accesses their records and who can make changes, and even which providers can access sensitive data. 

The technology can also be used for voting. For the US, which has recently been through a rollercoaster of voter fraud accusations following the presidential election, blockchain-based voting could have meant avoiding complications entirely. Using smart contracts, governments can validate a voter‘s identity and record their vote. They can then use this information to trigger an action after voting has finished. As blocks in a blockchain can’t be altered once they have been recorded, it would be almost impossible to hack, making the remote voting which has become so essential during Covid-19 a much safer process. And should the opposition call for a recount, this can then be done in a matter of minutes, rather than days.

These use cases are just a fraction of what the technology can achieve. Smart contracts can be used for anything from paying employees, to allowing e-commerce businesses to cut out costly payments processors and even empowering house sellers to handle transactions themselves, ensuring there is a secure and unchangeable record of the deal without the need for the expensive services of lawyers or housing brokers.

When will we see mainstream adoption?

Despite its promise, the second generation of blockchain has faced a number of issues around scalability, cost, transaction speed and network efficiency. On Ethereum, for example - currently the largest platform for smart contracts, transactions are still very slow as the public blockchain can only process roughly 15-20 transactions per second (TPS), whereas the likes of Visa can process 45,000 TPS. This has hindered mainstream adoption as the systems can’t scale to deliver on the transformational change promised by smart contracts.

As a result, the blockchain industry has been working to mature the technology and develop a third generation which can completely scale to replace existing global systems. This ‘third generation’ consists of blockchains like Cardano, EOS and Aion, decentralized software architectures that are almost infinitely scalable, have instant transactions, near infinite decentralization, much lower fees and only use one millionth the energy of the original Bitcoin blockchain. Ethereum also recently begun the transition to its next generation form, Ethereum 2.0, which will boast far greater transaction speeds.

Blockchain has 'come of age'

With third generation blockchains finally becoming a reality, the technology has come of age, and we could finally see smart contracts implemented on a global scale across thousands of businesses and government organisations. This could have a transformational impact for swathes of the population, widening access to financial services for those who have been previously excluded by extortionate fees, lowering the cost of entry for those looking to start a business, and making vital services like healthcare more efficient and secure.

Aparna Jue is Product Director at blockchain engineering company IOHK.