How Do Ethereum Smart Contracts Work?

How Do Ethereum Smart Contracts Work?

Ethereum smart contracts are an essential part of the Ethereum blockchain that can be coded into financial transactions or decentralized applications.

Smart contracts were first described in 1998 by Nick Szabo, but they did not really make their debut until being popularized by the Ethereum platform in 2015. Bitcoin even has protocols in its code to facilitate smart contracts, but Ethereum, because it is a platform for the development of decentralized applications, instead of just a medium for currency like Bitcoin, has gotten all the glory.

A smart contract is a lot like a “smartphone”: it is a go-anywhere, programmable, traceable, empowering version of its parent technology. Not necessarily bound to the old definition of a contract, a smart contract is a piece of code that executes, binds, and/or documents the terms of an agreement between two entities, based on conditions in the protocol. The smart contract may establish new legal terms of ownership or licensing changes, it may remove the need for a notary or a lawyer to be involved in standard transactions, it may minimize counterparty risks or even the need to negotiate.

Because blockchains are public, generally, using smart contracts on them increases transparency in dealings, minimizes costs, and can even be used to form decentralized autonomous organizations (like The DAO) in which many owners of a company are held together by smart contracts instead of corporate governance. Smart contracts can be used to streamline a supply chain, maximizing transparency and minimizing audit time. Connecting a smart contract to what’s called an “oracle” can automate execution of a contract based on real-world conditions, such as a farmer having a smart contract in place that automatically purchases certain supplies from his vendor if the weather predictions in his area meet certain criteria, as reported by an oracle which is trusted by the blockchain. In Bitcoin, smart contracts tend to be limited to certain conditions, such as multiple signatures that must be obtained for a transaction to execute, even though creative minds and real-world application can make these use-cases far more interesting than this example.

In Ethereum, however, the entire platform is a sandbox for developers to decide what business can be transacted over the network. With the trustless, secure, transparent environment of a blockchain that can be programmed to do essentially anything, with all of the computing power of the distributed network at its disposal, smart contracts can change the face of the internet as we know it. The Internet of Things, microtransactions, and tokenization are all buzzwords in the approaching landscape that will be built largely on the back of smart contract technology and blockchains.