Smart Contracts 101: Revolutionizing the way business gets done

(Photo: Shutterstock)

(Photo: Shutterstock)

The business world is a complex and ever-changing landscape, due in no small part to rapid advances in cryptocurrency and its associated systems. For the uninitiated, systems built on cryptocurrency can be unfathomably complex, with confusion exacerbated by their constantly changing nature. Unfortunately, in the world’s modern business climate, understanding these intricacies is critical to nurturing a thriving business. There may be no aspect of technology that is more greatly tied to this truth than that of smart contracts.

These complicated cryptographic codes are revolutionizing the way business owners conduct transactions online, and quickly securing their position as a vital part of the internet marketplace. While understanding smart contracts and their role in a business may seem daunting to the non-tech savvy, it is actually a rather simple system that even the most technophobic can grasp. More importantly, wrapping your head around smart contracts will provide unparalleled business opportunities and greatly streamline your virtual transactions!

An Intro to Bitcoin and Blockchain

Before one can understand a smart contract and its benefits, one must have a basic understanding of Bitcoin and Blockchain, the backbones of smart contract usage. More than just a buzzword or economic fad, Bitcoin is the most popular form of cryptocurrency on the market, providing a decentralized, digital currency with no central owner, repository or administrator. Anyone can earn Bitcoins primarily through two systems:

  1. Bitcoin mining – where users employ powerful computers to solve complex math problems that unlock Bitcoins
  2. Traditional online transactions – over 100,000 online merchants (and even some brick and mortar businesses) now accept Bitcoin as a form of payment

The reasons for which Bitcoin is becoming the de facto standard in online currency exchange are too numerous and nuanced for this article alone. However, the short answer is that the inability for users to trace Bitcoin use, resistance to inflation, high level of transaction security and non-existent transaction fees make Bitcoin a very attractive currency alternative in the virtual market.

The Blockchain is nothing short of a drastic and positive change in the very nature of online transactions.  It acts as a public ledger which automatically logs and time-stamps every Bitcoin transaction ever conducted, making them completely public matter. Not only does this improve security and transparency, but it also prevents double counting of a virtual currency that has little to no oversight at this time. Numerous external systems, like Sidechains and parallel Blockchains, deliver scalability and versatility.

What Exactly is a Smart Contract?

Though we have touted the merits of Bitcoin and Blockchain at length, you’re likely still asking yourself, “what is a smart contract, and where does it fit into all of this?” The simplest answer is that smart contracts are an “If-Then” statement for Blockchain. A smart contract acts as a pre-programmed set of logic instructions on the same system as the Blockchain, handling a cryptocurrency transaction in a certain way if the Blockchain meets the appropriate criteria. Think of the Blockchain as data storage, and smart contracts as calculations done on that data storage. All of these systems are running on multiple computer systems to ensure trustworthiness throughout all distributions.

One of the most intuitive ways to explain smart contracts is through an analogy. Suppose you’re going to fill your car up with gas, and you plan to prepay $20 worth of gas. Multiple unspoken agreements govern the entire process:

  • You put $20 into the gas pump and gas will come out to fill your car
  • You don’t put $20 into the gas pump and gas will not come out to fill your car
  • You don’t put $20 into the gas pump and gas still comes out to fill your car. This is bad.
  • You put $20 into the gas pump and gas does not come out to fill your car. This is also bad.

Smart contracts employ a similar set of unspoken agreements, considering Blockchain data in the process, when users conduct transactions. In this way, smart contracts provide security to your virtual assets through unspoken, pre-programmed agreements. A computer program, defined by a pre-determined set of rules, automatically controls your cryptocurrency transactions.

Why Use Smart Contracts?

The idea that a piece of software has complete and total control of how your money moves is definitely a tough pill to swallow. However, the reality of smart contracts is that they provide unparalleled security for your virtual transactions.

By using a pre-determined set of conditions that the Blockchain data governs (which, as we already discussed, is secure and decentralized from any one individual’s power), payments are guaranteed to be made when fair conditions are met. This eliminates the need for escrow services, or any other third-party transaction security mediator. Furthermore, the nature of smart contracts confers the same transparency to its code that Blockchain data exhibits, so the logic governing a transaction is not hidden knowledge from any parties involved. 

Since the smart contract code runs in parallel on all computer systems involved in the transaction, everybody is able to validate the results of the transaction. Theoretically, it is impossible to cheat or be cheated by other participants in a transaction when using a smart contract. In addition, smart contracts provide unparalleled flexibility in determining how your money moves around. While traditional banking systems only provide basic mechanisms of manual money transfer between accounts, you can program a smart contract to perform complex movements of finances based on specific parameters. For example, you could easily design a smart contract that automatically splits your money in half and moves one portion to a different account whenever the balance reaches a certain threshold, if you needed such a system.

Downsides of Smart Contracts

Like all computer codes, smart contracts are vulnerable to human error when being designed, and a small portion of botched code could spell disaster for someone’s finances. Furthermore, smart contracts are relatively inflexible in terms of reworking a transaction due to unforeseen circumstances. No matter what happens before, during, or after the processing of a smart contract, the system carries out the contract to completion. In contrast, you could rescind a regular contract in court if need be. Finally, while decentralization carries a plethora of benefits, it is also costly for everyone involved, as each individual node that participates in the network has associated operational costs.

Smart Contracts and the Blockchain Protocol in the Context of Your Business

Smart contracts, like many Blockchain solutions, are not one-size-fits-all solutions for any business, and the suitability of such a system will be up to the business owner’s discretion. However, nobody can deny that the number of business owners who will benefit from the security of smart contracts is rapidly increasing, as business dealings are increasingly relegated to the virtual world. 

The question is more typically one of whether your business could benefit from incorporating Bitcoin payments. So long as your business operates on Bitcoin, there are almost no disadvantages to employing smart contracts. However, the scalability limits of Blockchain play into these decisions.  Unfortunately, blocks of data (i.e. transactions) in the Blockchain are currently limited to 1 megabyte, which can cause delays in large transactions. If your business makes frequent, large transactions, the current inability to scale Blockchain protocols and smart contracts may play against you. 

Bitcoin is currently able to perform about 1/100th of the number of transactions per second that VISA can, making it more suited to small niche businesses. Still, it is often these small niche businesses who are most vulnerable to problems with payment security, and solving that issue is what smart contracts are all about.

The Future of Blockchain and Smart Contracts

Though there are many roadblocks to scalability in the current configuration of Blockchain, there are also many world-class software engineers whittling away at the problem on a daily basis. Unlike physical transaction systems, finding the right logic to improve scalability is only a matter of time – just as the large-scale implementation of Bitcoin is only a matter of time. Smart contracts may not be the best solution for your business right now, depending on its size, and that is okay. However, if you have the latitude to implement smart contracts and begin dealing with Bitcoin, you will be far ahead of the curve when the rest of the world inevitably joins in on the virtual currency revolution.

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