Crypto-Currency Basics: What Is a Smart Contract?

The two leading crypto assets are Bitcoin and Ether. A large portion of the population groups these crypto-currencies together as if they are one in the same. However, there is a massive difference in their underlying technology, and that difference is centered around the smart contract.

Ethereum was built based on the Bitcoin blockchain, but it included smart contracts. This is so developers can build more sophisticated applications on top of the blockchain. Bitcoin, on the other hand, was built to be a decentralized currency.

The Difference Between a Smart Contract and a Typical Contract

A standard contract between two parties is usually a long document written by a lawyer. Once each party agrees to the terms of the contract, they then sign their names. This document can then be enforced in a court of law.

On the other hand, a smart contract is programmed rather than written. Since it has been programmed, the software will perform each action specified in the contract. There is much less room for miscommunication and misinterpretation of the contract. The program will also enforce any obligations or penalties that may arise.

Examples of Smart Contracts

ICO (Initial Coin Offering) has become a very popular form of crowdfunding with the rise of crypto-currencies. An ICO is nothing more than a smart contract used to issue a token that denotes ownership in a product or company. A simple ICO contract will give X number of issued tokens for one ether.

Purchasing Real Estate is another example of a potential smart contract. If someone would like to purchase a home, they could go online, find the home they’d like to purchase, and exchange currency for the deed right there. Since the current owner listed the home, they can enter into a contract agreement that exchanges the payment—in digital currency—for the title of the house. The blockchain then has a record of this transaction, so there is no dispute beyond the transaction point that there is a new owner of that home.

Smart Contract Benefits

Instant Trust

Both parties know that the contract is in place and enforced, meaning you don’t need to know the other party before entering into an agreement.

Contract Immortality

Once the contract has been agreed to, the transaction stating the agreement lives on the blockchain. No need to worry about misplacing a document.

Reduced Costs

There is no need to rely on a broker or lawyer. Everything is handled by software.

Drawbacks of Smart Contracts

Smart contracts are an incredibly promising technology, however, they are not without their faults. For starters, they are not changeable. Once the contract has begun, one cannot simply go back and adjust specific parts of the software even if change is favorable for both parties in the agreement.

A major issue with smart contracts is any sort of bug or error in the code. There have already been numerous problems associated with companies that have had vulnerabilities within their smart contracts. The code for most smart contracts is made available, so be sure to vet the software before using it!

Smart contracts are incredibly powerful. They turn the blockchain into a virtual computer and extend the application limits of the technology.

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