When we refer to contracts, we often imagine two individuals meeting to sign a physical document that contains a binding agreement both must adhere to. Along with this, an intermediary must be present to make sure that both parties follow the terms of the agreement.
However what if we no longer needed a physical document to sign or a third party to enforce the contract? What if we could automate this whole process by relying on code and the immutability of blockchain technology instead?
This is the promise that smart contracts bring, and you can learn more about them and how they relate to Ethereum below.
WHAT ARE SMART CONTRACTS?
In the real world, traditional contracts work by allowing a third party (like a lawyer) to ensure that all conditions in an agreement are met by all parties involved. A quick example of this would be the company Kickstarter.
On the fundraising platform, you can create a project, set a funding goal, and start collecting money from other people who believe in your project. Once the funding goal is reached, only then would Kickstarter release the funding to you.
If the goal is not reached, then Kickstarter automatically refunds all persons who contributed to the fund. In this scenario, Kickstarter is the trusted third party that handles the money. Of course, this third party requires transaction fees to execute the contract.
On the other hand, a smart contract eliminates the need for third parties by writing the terms and conditions of an agreement in lines of code. Similar to a computer program, smart contracts self-execute in a blockchain network once all conditions are met. Once the contract is executed, it becomes traceable and irreversible in the blockchain.
Going back to the Kickstarter example above, you can create a smart contract in place of the third-party fundraising platform to speed up the process and save up on transaction fees.
To do this, you can program the smart contract to hold all the funds until the goal is reached. If the project gets fully funded, the funding automatically gets passed on from the holding pool to your account.
If the project fails to meet the goal in the set time limit of the contract, the funding is then automatically reverted from the held pool back to the contributors.
HOW DOES THIS RELATE TO ETHEREUM?
Smart contracts can be programmed in a special programming language called Solidity. This language uses a syntax similar to JavaScript and was built specifically for Ethereum. This means that Ethereum is the biggest blockchain network that supports smart contracts as it was specifically built for them. Smart contracts give Ethereum security and minimize the exchange costs in every agreement.
What enables users to interact with a smart contract and the (Ethereum) blockchain is called a DApp or decentralized application. A DApp is a blockchain program that records and saves data that operates in an independent P2P network of computers.
Disclaimer: The information and publications in this article are not intended to be and do not constitute financial advice, investment advice, trading advice, or any other advice or recommendation offered or endorsed by Coins.
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