Smart Contracts: What Are They, How They Work – Forbes Advisor Australia

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Imagine standing in front of a vending machine. You select your favourite chocolate bar, insert the coins, and instantly, your treat tumbles down. No shopkeeper, no cashier, just a direct exchange. This process mirrors that of smart contracts. In many ways, they are digital vending machines that can handle a vast range of tasks, from automating property transfers to ensuring artists receive their rightful royalties.

At their core, smart contracts are digital agreements with hard-coded terms and conditions. Using the robust architecture of blockchain technology, every contract, once forged, stands immutable—firmly set in digital stone. This ensures utmost transparency, security and trust between parties that may never meet or interact with each other.

While the idea has been around for a while, it’s platforms like Ethereum, with millions of smart contracts operating around the clock, that are the harbingers of a new age of digital agreements and transactions.

Smart contracts are not just digital agreements but are intricate coded instructions designed to carry out specific tasks. Think of them as digital rulebooks. Once you’ve agreed to the rules and set them in motion, the code ensures that every action adheres to those guidelines.

For instance, if you’ve set a rule that a payment will be released once a task is completed, the smart contract will automatically handle this, ensuring timely and accurate execution. It’s this automated precision that distinguishes smart contracts from traditional agreements.

This concept has been introduced previously. The term “smart contract” was coined in the 1990s by visionary computer scientist Nick Szabo. He imagined a world where certain agreements could be self-executing, reducing the need for intermediaries or trust in the other party. With the advent of blockchain technology, his vision has come to life, and contracts have received a digital upgrade.

Today’s blockchain technology has elevated this concept to a practical reality. Contracts aren’t just written and signed; they are programmed, automated, and self-executed, marking a significant leap in handling agreements in the digital age.

Smart contracts work based on coded instructions embedded within them. Here’s a step-by-step breakdown of their operations using the vending machine analogy:

Throughout this process, the beauty of smart contracts is their autonomy. They don’t require intermediaries like banks or lawyers. Instead, they rely on the predefined, transparent rules set within them, automating trust and ensuring every party gets what they’re promised.

Smart contracts usher in a new era of digital transactions, offering multiple advantages over traditional methods:

Smart contracts, with their blend of technology and transparency, promise a future where transactions are quicker, safer and more equitable for all participants.

While smart contracts offer transformative advantages, they aren’t without their drawbacks. Here are some potential pitfalls to be aware of:

Despite these challenges, it’s essential to remember that the world of smart contracts is still evolving. Many of these hurdles might be addressed and overcome as technology and frameworks develop.

The transformative nature of smart contracts extends beyond today’s applications, promising to reshape numerous industries and redefine traditional operations:

For everyday Australians, this means a future where many of the cumbersome processes we encounter in day-to-day life are simplified. It paints a picture of a world where transactions are swifter, more transparent, and more equitable. As technology continues to evolve and as industries embrace the power of smart contracts, we potentially stand to gain much in the way of efficiency and transparency.

While smart contracts offer a way to automate and simplify many transactional processes, they aren’t set to replace lawyers entirely. Legal expertise goes beyond drafting contracts and encompasses negotiation, legal advice, representation, and understanding of nuanced human situations.

Smart contracts can handle straightforward, coded conditions but lack the human judgment and comprehensive legal knowledge lawyers offer. So, while lawyers might use smart contracts to improve efficiency in some areas, their broader roles in the legal system remain indispensable. Smart contract knowledge will likely become an essential skill for lawyers in the future.

Yes, smart contracts are stored on the blockchain. Once a smart contract is created, it’s deployed to the blockchain, where it gets its unique address. However, there’s a significant differentiation between centralised and decentralised blockchains that can affect the smart contracts deployed on the chain.

Decentralised blockchains, such as Ethereum, are not controlled by a single entity but rather a vast number of distributed entities that all work together to verify legitimate transactions and ensure the system is free of fraudulent transactions and bad actors. Smart contracts deployed on a decentralised blockchain are set in stone, and the decentralised nature ensures that they cannot be tampered with. This makes them transparent, secure and immutable.

On the other hand, centralised blockchains are controlled by a single entity. This allows the entity to manage the transactions on the chain, approving, cancelling or reversing at will. Centralised blockchains are often used in private settings where a single entity requires complete control over the system. Smart contracts deployed on a centralised chain can be altered, or the entity in control can reverse its actions.

Ethereum is a decentralised blockchain platform designed specifically for creating and executing smart contracts. A smart contract in Ethereum is a self-executing contract where the terms of agreement or conditions are written into lines of code. They can process transactions, manage agreements, and even create other decentralised apps.

Ethereum has its programming language, called Solidity, which developers use to write these contracts. The platform’s security, decentralisation and community have made it a leading choice for developers leveraging smart contract capabilities.

Patrick McGimpsey is a freelance writer passionate about crypto and its impact on the financial world. Currently working as the content lead for Australian startup CryptoTaxCalculator, Patrick has also covered the crypto industry for Canstar and The Chainsaw. Patrick has over seven years of experience in the crypto space and has previously shared his knowledge with the AML and fraud departments of Australian financial Institutions.