Smart contracts are an increasingly important part of the blockchain space and eventually are expected to become a foundational technology for everyday business and transactions. Understanding the basics of smart contracts is critical to truly appreciating the full potential of blockchain technology and the innovations they will enable in the not-so-distant future.
In their most basic form, smart contracts are self-executing software programs that live inside blockchain ecosystems and can perform actions without the need of human input. While there are software programs that can operate autonomously just like smart contracts, what makes the latter different is that once they are deployed on the blockchain they cannot be changed. This is also known as immutability.
Why is immutability a killer feature of smart contracts?
In this case, "killer" is a knife that cuts both ways. The primary benefit of immutability in smart contracts is that it removes the need for parties to trust each other to engage in transactions.
By definition, a contract is a promise enforceable by law, usually involving a financial transaction. Let's use an example to explore how the same situation would be handled by a conventional contract VS a smart contract:
Charlie's air conditioning (AC) system has stopped working and he calls Billy (a repair man) to come fix it. Billy comes to inspect the system, identifies the problem, gives Charlie an estimate, Charlie agrees, Billy fixes the AC and Charlie pays him.
Now let's say there is a dispute: Charlie does not think the AC is cooling properly after the repair, and wants some of his money back.
In a conventional contract, Charlie and Billy would try to work together to compromise on a resolution that works for both, and if they are not able to work things out, the issue may have to be taken to a neutral third party (a court of law) to settle the issue. This process can be lengthy and expensive.
Using a smart contract, all the rules are spelled out ahead of time with checks and balances along the way, with the smart contract enforcing the rules without any bias based on the steps and actions taken along the way. While this is very powerful for simple transactions, it becomes increasingly difficult to implement as the complexity of the transaction increases.
Going back to the issue between Charlie and Billy: How do we know what an acceptable temperature is based on the type of dwelling, insulation, personal preference? How do we know that Billy truly made the right repair and did not miss anything? These and every possible permutation of questions would have to be identified ahead of time and coded into the smart contract for it to be effective. Additionally, the smart contract cannot be changed once deployed to the blockchain, so even if all the possible scenarios have been identified, there cannot be any errors in the code.
When does it make sense to use smart contracts?
This answer will change over time as blockchain technology and smart contracts evolve. In the meantime, smart contracts are best suited for transactions with simple "if this then that" logic with clear outcomes that can be measured mathematically. This is why the first and dominant use-case for smart contracts is in financial transactions. All the data needed to execute the smart contract lives within the same blockchain ecosystem and is based on clear rules and objective information.
What is the future of smart contracts?
The answer to this question is evolving every day, and at the moment the possibilities are endless. There are some proponents who believe smart contracts will revolutionize the world, while the more pragmatic folks think this technology will be more evolutionary than revolutionary. Only time will tell.
Some of the industries that are or could be well-suited for the integration of smart contracts include Finance, Procurement, Supply Chain, Real Estate, Healthcare, and many others.
The evolution of smart contracts will go hand-in-hand with the evolution of blockchain technology itself. There are still many obstacles that leading blockchains need to overcome before achieving mass adoption, but the pace of innovation in this space continues steadily and new breakthroughs are being achieved every day.