What are Smart Contracts?
By: Lukas Wiesflecker
Tags: Cryptocurrency, Smart Contracts, Ethereum, Blockchain, Ethereum Blockchain

Smart Contracts are a functional extension of Blockchain. They are self-triggering contracts, which are linked to fixed conditions of two parties. These conditions are unchangeably recorded in the protocol code. The most popular platform for executing Smart Contracts is Ethereum.

How do Smart Contracts work?

Smart Contracts are small programs that run on a blockchain and are based on a simple if-then function that they can execute automatically. Similar to a classic contract, conditions and actions are defined. Smart Contracts benefit from the characteristics of the blockchain and are unchangeable, transparent, and do not require an intermediary for processing.

Instead, the functionality of the blockchain guarantees a secure execution of contracts at minimal costs. The advantages are manifold. Intelligent contracts can be executed automatically and without time without being dependent on intermediaries or high transaction costs.

Within a blockchain, a Smart Contract acts like a separate account with a public address, but without an owner. Virtually no one has the private key to this account. Once it is created, no one can access it or make changes. Instead, contract content is laid down in the form of conditions and actions that the account executes automatically. It can also connect to other funds with which it should interact. To do this, the respective account holders must accept the contracts in advance using their digital fingerprint.

How can Smart Contracts be used?

The areas of application of Smart Contracts are enormous. In the following, some simple examples of use are described.

The representation of a repetitive payment should help to make this functionality clear. In the classic blockchain system, for example, Sarah can pay her monthly rent by transferring two Bitcoin to her landlord and, in return, receives the right to move into the apartment. However, she would have to repeat this process every month, similar to an instructed bank transfer. With a Smart Contract, Sarah can enter into a contract with her landlord that makes a recurring and automated payment. To do this, she defines the condition that the first day of each month must be the first day of the month. When this condition is met, a transaction is initiated from her account via the Smart Contract account to the landlord’s account. If the landlord and Sarah agree to this contract, the Smart Contract connects to the respective stores.

What sounds simple as a standing order at a bank, but thanks to the blockchain technology, there is no intermediary involved; in this case, the bank. Theoretically, additional roommates could be implemented in the Smart Contract. Or it could be defined that service charge repayments remain on the Smart Contract account to offset them against future rents.

Ethereum Smart Contract Ethereum is the most popular and well-known blockchain for Smart Contracts

Another interesting case is decentralized power generation, in which private solar power producers and consumers interact without intermediaries. Here, the blockchain can document the amount of energy consumption of the consumers and the amount of solar production in a decentralized and tamper-proof way. For example, this is done by means of smart light bulbs that feed information about power consumption directly into the blockchain. Smart contracts could automatically initiate the corresponding payments from consumers to producers. Power companies would be superfluous in such a system since the blockchain creates trust, and smart contracts would take over the contract conditions and automated payment flows.

The actual possibilities for smart contracts go far beyond the examples described. Smart Contracts can be designed as complex as desired and contain numerous parties and conditions. As soon as conditions and actions can be defined and digitalized, Smart Contracts can take over this work.

In the course of progressive digitization, for example, the work of lawyers, notaries, or authorities would be made easier or even superfluous. The Internet of Things could use the interface to Blockchain to make automated settlements and payments in real-time.

Initial Coin Offerings and DApp’s

Smart Contracts are already being used in the area of ICO’s (Initial Coin Offerings). These are swarm financings of companies where a payment to an individual account directly initiates a repayment in shares (tokens). In theory, Smart Contracts can even automate entire companies.

If several Smart Contracts are combined, complex programs decentralized by the blockchain can be constructed. These applications are called decentralized apps, or DApp’s (Decentralized Applications). One of many examples would be Golem, a decentralized network for renting and leasing computing power.

Many cryptocurrencies that do not have their blockchain infrastructure are only complicated DApp’s that runs as a program on an existing blockchain.

You can compare this model with that of an online web service that you pay to use. A good example is the Ethereum blockchain, which provides its sophisticated operating system called Ethereum Virtual Machine (EVM). For tenants to run their programs or applications on the EVM, they have to pay for so-called gas. With EVM, gas is produced in the currency of Ethereum (ether), after which the program code of the applications is executed in the entire Ethereum network, and the tenants can run their programs on the EVM.

Moreover, since most blockchain technologies are based on the open-source principle, creating innovative DApps is open to everyone. Therefore, it will be exciting to see which decentralized applications on which operating systems will influence the private and the professional environment in the future.

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