SMART CONTRACTS: HOW THEY WORK AND WHY THEY ARE NEEDED. PART 1

The XXI century is the century of information technologies. Every day innovations are becoming more and more closely integrated into our lives. Every day, new breakthrough technologies appear: blockchain, cryptocurrencies, Big Data, neural networks, artificial intelligence, the Internet of Things, quantum computers. Among information technologies, the technology of smart contracts, which are often used in the field of cryptocurrencies, is regularly mentioned. Today we will discuss what they are, how they work and what are the areas of application of smart contracts.

Classic contracts

A classic contract used in office work is an oral or written agreement between the parties, in which the rights and obligations of the participants in the transaction are spelled out. The fulfillment of the terms of the contract is guaranteed by state legislative acts. If one of the parties does not fulfill the terms of the contract, the other party has the right to apply to the court, which will determine the party guilty of violating the terms of the deal and oblige the violators to bear responsibility.

People meet with classic contracts everywhere: the conclusion of an apartment rental agreement, a car and other property purchase and sale agreement, the drafting of a job contract, insurance, and other services — all the described types of relationships between people are carried out by concluding a contract.

The use of classical contracts is associated with certain difficulties. Among the most significant complications that prevent the mass use of classical contracts is the need to draw up a contract between the parties to the transaction by professional specialists, otherwise hidden inaccuracies may remain in the terms of the contract, which can then be used by one of the parties for improper fulfillment of the terms of the contract, or their complete violation.

At the same time, the cost of the services of professional lawyers for making contract agreements is sometimes quite an impressive amount. In addition, when drafting contracts, lawyers use complex professional vocabulary that is incomprehensible to ordinary people who are not familiar with professional terminology and the subtleties of the legal language.

In case of disputes between the parties of the contract, they apply to the court, which does not always objectively perceive the terms of the conflict between the parties. As a result, the party whose rights have been violated may not receive the restoration of their legitimate interests. In addition, the trial itself will require additional financial and time resources, and the decision may not always be fair.

Thus, the use of classical contracts involves the use of a large number of intermediaries. In addition, the terms of the contract can be interpreted in different ways, depending on the subjective factors involved in the transaction, primarily human.

Up to a certain point, classical contracts remained the only form of concluding the terms of a transaction between counterparties. But everything changed with the development of digital technologies, which began a new era of human relationships.

What is a smart contract?

A smart contract is an automated self-executing contract, the terms of which cannot be changed during the transaction and are written in the form of computer code. Smart contracts include a set of protocols that guarantees the fulfillment of the terms of the transaction by counterparties.

The program code of smart contracts can be used an infinite number of times and can be programmed for a wide variety of people’s needs. Smart contracts make transactions traceable, transparent, and irreversible.

If the programmed condition is met, the smart contract automatically performs the corresponding action. For example, in the case of a transaction for the sale of a real estate object, the buyer transfers money to the program, which is “frozen” there until the seller fulfills his part of the terms of the transaction. In case of non-fulfillment of the terms of the contract by the seller — the transaction amount is returned to the buyer. If all the conditions are fully met by the participants, the assets are exchanged.

This technology is innovative since the terms of the contract cannot be changed or canceled. Smart contracts allow you to perform trusted transactions and agreements between anonymous parties without the need for a central authority, a legal system, or an external enforcement mechanism.

Example of a smart contract for the sale of a car

Classic and smart contracts have the same fundamental basis — both types of contracts are agreements between two or more parties that undertake to fulfill several conditions.

They have the same basic elements

  • Voluntary consent to the participation of the parties in the contract;
  • Contract object;
  • A single ultimate goal of the contract for all participants.

At the same time, classic and smart contracts have three main distinguishing factors:

  • Type and method of writing the terms of the contract;
  • Legal obligations;
  • The concept of compliance with the conditions.

Just like classic contracts, smart contracts allow you to make any form of transactions between participants: exchange of assets, currency, property, lending, and other forms of transactions.

Smart contracts have gained wide popularity with the emergence of blockchain technology and cryptocurrencies. At the same time, the use of smart contracts does not necessarily have to be associated with the use of decentralized systems and digital currencies.

In the case of deploying smart contracts based on the blockchain, its program code and the terms of the agreement contained therein are stored in a decentralized distributed system. Outside of the blockchain, a smart contract will be just a program code.

Smart contracts may turn out to be a new stage in the evolution of economic decentralization, and thanks to it the need for intermediary services such as banks, brokers, microfinance organizations will completely disappear.

History of smart contracts

The history of smart contracts begins in 1993, when an American computer scientist and cryptography, Nick Szabo, who developed an algorithm for a decentralized digital currency called “Bit Gold” back in 1998, 10 years before the appearance of the first cryptocurrency — Bitcoin, proposed the term “smart contract”. He wanted to expand the functionality of electronic transaction methods into the digital sphere.

According to some information, Nick Sabo himself is hiding under the pseudonym Satoshi Nakomoto, although he denies this.

Nick coined the term “smart contracts” to explain the concept of developing protocols, which, in his opinion, were to become a new highly developed stage of contractual relations between people and related business practices in the field of e-commerce.

He believed that the development of “smart contracts” based on cryptographic protocols and other digital security mechanisms could be a significant improvement over classical legal contracts.

In 1996, Nick Szabo published a document on the concept of automated self-executing contracts. Szabo defined smart contracts as computerized transaction protocols that fulfill the terms of a contract. He used the concept of “smart” in a figurative sense and stated that artificial intelligence would not be used in his concept of smart contracts.

The original example of the prototype of a smart contract from the concept of Nick Szabo is a vending machine. A person puts coins into a vending machine, which gives him a drink or a chocolate bar. The interaction between a person and a vending machine is a classic example of a purchase and sale contract transaction. The difference between a transaction between a machine automaton and a person from a classical contract is that the machine independently controls and fulfills the terms of the transaction. If the buyer agrees with the terms of the “contract”, he puts money into the machine, which automatically makes a deal (issues a product), if the terms of the transaction are fulfilled (the buyer threw the required number of coins).

It was possible to implement the concepts proposed by Nick Szabo only in 2008 when the principles of smart contracts laid down by Nick found their place in the Bitcoin blockchain. However, these principles turned out to be extremely limited, aimed exclusively at the functioning of the cryptocurrency.

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