What are smart contracts?

Smart contracts are digital contracts that define the terms of a transaction via computer code. They also
verify, execute, and enforce that transaction without the need for a third-party intermediary.

Smart contracts explained

Whenever someone buys a house, begins a new job, or purchases a candy bar, a contract is created
between the two (or more) parties involved in the exchange. This contract defines and records the
terms of the transaction, denoting the required actions of each participant. For example, if you give the
cashier a dollar, the cashier must give you the candy bar. A standard contract’s sole purpose is to define
these terms.

Alone, a standard contract has no power to enforce the terms that it defines. Instead, a legal or
governmental third-party oversees the execution of a standard contract, ensuring that each party
faithfully carries out their end of the bargain; if the terms are violated, the transacting parties must rely
on this intermediary to rectify the broken contract.

However, thanks to recent advancements in distributed ledger technology, lawyers or other

Smart contract origins

In 1994, legal scholar and computer scientist Nick Szabo envisioned a computer protocol which not only
defined the terms of a transaction, but also completed the transaction itself. While standard contracts
rely on lawyers or government agencies to enforce and execute the described exchange, these “smart”
contracts are self-enforcing and self-executing.

To explain his idea more concretely, Szabo compared the smart contract to a vending machine. Imagine
you want to buy a candy bar from the store. To do so, you have to fulfill a standard contract: you pay the
listed price, and the store grants you ownership of the candy bar. Of course, this exchange does not
happen on its own. A cashier is needed to execute the transaction and a legal body is needed to enforce
it. For instance, if the cashier breaks the terms of the contract by accepting your money but then
refusing to give you the candy bar, policemen or lawyers may be required to enforce the contract.

In contrast, vending machines complete all aspects of a transaction independently. When you want to
buy a candy bar from a vending machine, all you have to do is select a product and input money. The
machine verifies your payment, executes the transaction, and moments later you have your candy bar.
Assuming the vending machine itself is secure, there is no need for a cashier, a lawyer, or a government
agency. The transaction is atomic; meaning it should happen perfectly every time, or not at all.

Like vending machines, smart contracts fulfill an agreement without middlemen. Transacting parties
simply agree on their terms, put a cryptocurrency coin into the program, and then the smart contract
executes the desired digital exchange.

How do smart contracts work?

When Nick Szabo proposed them, smart contracts were infeasible given current technology. For smart
contracts to function, they need a secure digital infrastructure which can reliably support intermediary-
free transactions. In 1994, this technology simply did not exist. Now, due to recent advancements in
distributed ledger technology (DLT) like blockchain and hashgraph, smart contracts are a reality.

Distributed ledgers are platforms which enable users to securely transact without the need for trusted
intermediaries. In terms of the analogy, if smart contracts represent the software that executes a
vending machine transaction, a distributed ledger represents the hardware of the vending machine
itself. More specifically, the distributed ledger represents the mechanisms which take in currency,
transport the product, and securely (but transparently) carry out the exchange behind tamper-proof
locks and bullet-proof glass. While we won’t go into detail about how distributed ledgers work in this
article, you can learn more by visiting "What are distributed ledger technologies (DLTs)?"
Atomic swaps

Distributed ledgers are uniquely suited to host smart contracts because they allow for atomic swaps.
Atomic swaps are all-or-nothing exchanges. In other words, a transaction on a DLT will either happen
precisely, or not at all. This functionality perfectly aligns with the goal of a smart contract: to define, self-
execute, and enforce a transaction to the letter. By harnessing the power of atomic swaps, smart
contracts can ensure that their terms will be followed correctly, or the entire transaction will be void.

Atomic swaps are transactions which are either carried out completely or not carried out at all. Smart
contracts rely on atomic swaps to self-execute and enforce the terms of a transaction without requiring
third-party oversight.

Over the last few years, smart contracts have grown and evolved. The computer language Solidity was
developed specifically for smart contracts, granting developers tools to quickly build complex digital
contracts. While Solidity was originally built for the Ethereum network, Hedera Hashgraph also supports
the Solidity language.

Why are smart contracts useful?

Smart contracts’ primary advantage is their independence. Without middlemen, there is no need to pay
middlemen. This can dramatically reduce costs for major transactions. Additionally, there is no need to
trust middlemen to verify and execute smart contracts correctly and quickly. As a result, smart contracts
can be cheaper, faster, and more secure than traditional contracts.

Also, smart contracts inherit the transparency and security of the distributed ledger they run on. On a
public ledger, all transactions are visible to members of the network. This transparency allows you to
verify your transaction and rest assured that the exchange happened correctly. Moreover, the records of
your transaction cannot be easily altered or deleted on a distributed ledger, and if they are, this change
can be made visible to you. These security and transparency benefits are unique to public ledgers and
smart contracts.

Finally, smart contracts make complex transactions easy. While smart contracts can be used for simple
transactions, they can also define and complete intricate, multiparty exchanges with precise timelines.
Languages like Solidity make it possible to code even the most complex transactions, and once a smart
contract has been written, it can be used over and over again. Additionally, multiple smart contracts can
be used in tandem to execute even more elaborate exchanges.
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