What is a Smart Contract?

What is a Smart Contract?

Smart contract are undeniably one of the important factors in crypto transactions. As an investor, you may already be familiar with this term, given that this automatic program is often found in every transaction process on blockchain platforms around the world.

Basically, a smart contract is an agreement between the parties involved in the contract that is done entirely automatically. Its use is often carried out on platforms that accept payments in cryptocurrencies. Various industries such as real estate, finance, retail, and telecommunications have widely applied this technology in their transaction processes.

Do you want to know more about smart contracts? If so, let’s see the full discussion through this article.

Who creates smart contracts?

Believe it or not, smart contracts have actually existed for a long time even before blockchain technology was created. Its name has indeed started to be widely known since it was used by Ethereum, one of the popular blockchain platforms in the world. Many people are unaware that smart contracts are also present on the Bitcoin network. However, due to the Turing-incomplete Bitcoin programming language, the functionality of Bitcoin smart contracts at layer 1 or on chain is more limited. Examples of smart contract features that are available at layer 1 bitcoin are:

  • Multiple signature scripts
  • Pay to public key hashes
  • Time locked transactions
  • Pay-to-Script-Hash (P2SH)

With the taproot upgrade in 2021 which has been implemented in bitcoin core, there are more and more smart contract functions that can be developed at layer 1 / on chain bitcoin. For smart contract functions that cannot be developed at layer 1, Bitcoin can be developed at layer 2. There are now various types of layer 2 Bitcoin, such as:

  • Lightning network
  • Liquid network
  • Rootstock
  • Drivechain
  • Stacks

The initial idea came from the computer scientist and cryptographer, Nicholas Szabo, also known as Nick Szabo, in the 1990s. The name Nick Szabo is certainly no stranger to the cryptocurrency world. He is often regarded as the original figure behind the creator of Bitcoin, Satoshi Nakamoto, whose identity is still a mystery. This is in part due to his research related to digital contracts, which are now known as smart contracts.

The term smart contract was first introduced in early 1994. It began with Szabo’s idea to store contracts in the form of computer code. The University of Washington Computer Science & Engineering graduate combined formal and secure interface protocols using computer networks for its users.

What is the purpose of smart contracts in the blockchain?

Every type of transaction is always supported by a written contract. Unfortunately, traditional contracts are starting to feel less practical, and often a source of business and legal conflicts. The solution is to replace these traditional contracts with “smart” or smart contracts.

In the world of blockchain, smart contracts are created to simplify every process of business transactions and trading between anonymous and identifiable parties. This step also doesn’t always require an intermediary such as a lawyer, making it even easier. Their use can also reduce formality and costs, without sacrificing authenticity and credibility, since the entire process is done automatically through a trusted computer network. Any information contained in the contract is visible to all participants in the blockchain network.

You may feel hesitant to enter information regarding the contract that has been made, especially when it comes to competitive strategies in the blockchain. However, there is no need to worry.

Nearly all blockchain platforms have been permission-driven so that the information created is only visible to the people involved in the contract. As an investor, you only need to choose a blockchain platform that implements certain options according to your needs.

How do smart contracts work?

Nick Szabo likens how a smart contract works to using a vending machine. The vending machines have been specially programmed so that they will only dispense the desired product after the buyer has put in enough money. If the money is not enough, then the vending machine will not provide the product.

Another illustrative example is when a market asks farmers for 100 ears of corn. The first step is to lock all forms of agreements, including funds, that have been agreed upon in the smart contract. When the farmers have fulfilled their obligations to the market, the funds will be disbursed immediately. However, if the farmer misses the promised deadline, the contract is automatically canceled and the money will be returned to the client.

The two examples above are small use cases of smart contracts, where money can be programmed to follow rules written in code on the blockchain. That is, the computer network will take action under various conditions according to the written code. For example, conditions for registering contracts, disbursing funds, canceling contracts, issuing tickets, sending notifications, and so on.

Characteristics of smart contracts

Basically, digital contracts such as smart contracts have a lot in common with conventional contracts. Both include agreements that have been agreed upon between two or more parties. Part of what makes them different is the ability of digital contracts to translate agreements into computer code and run on the blockchain.

Simply put, a smart contract is some code written on a blockchain to track agreements and facilitate asset transfers. This system can also help the involved parties who wish to exchange money, property, shares, or other valuable things.

That is why most of their characteristics come from the underlying blockchain technology, namely:

  • Safety: The use of cryptography can help secure contracts and prevent certain parties from wanting to change the original agreement.
  • Transparency: Once running on a public network, anyone can see their transaction history and what the technology is used for.
  • Free from third parties: Its application does not need to involve intermediary assistance in the verification process.
  • Near real-time execution: Usually, smart contracts will run almost simultaneously for all parties, although in some cases, it depends on the underlying connection and network.
  • Decentralization: This technology works in a decentralized manner. Once used, the contracts made cannot be changed or controlled by any centralized party.
  • Accuracy: Written in coded form, smart contracts do not use ambiguous language, which often causes miscommunication.

Implementation of smart contracts

With today’s technological advances, their use is becoming increasingly popular in all sectors, especially in the business world. Here are some of the most prominent implementations.

Real estate

In the world of real estate, smart contracts can be used to replace brokers who often take a significant fee from the sale price of the building. This method will help building owners save costs as there is no need to pay intermediaries. Buyers will also acquire buildings faster than they would with traditional brokers.

Health industry

The application of smart contracts in the healthcare industry is generally done to record and transfer patient data safely. This allows patients to control their own data, including determining whether they want to sell medical data to researchers for research purposes.


Insurance policies are one of the industries that most often use the benefits of this technology. The providers usually enter users into smart contracts. All terms will be written in a smart contract, which participants must read and sign when they agree to it. When a valid claim is made, the funds will be disbursed automatically, and no party can hold it for unilateral interests.

Supply chain

One of the most popular implementations of smart contract technology is related to the supply chain. The complexity of the network often makes it difficult for companies to track product custody and follow payment schemes. This is where the role of smart contracts comes in, as they can automate and spread incentive funds to all parts of the supply chain to increase accountability. Their application also helps in determining which party chooses to cooperate or not. This step can save both parties time and money in the long run.

Pros and Cons of Smart Contracts

The presence of this technology is believed to be able to change work systems in various industries. This is inseparable from the many benefits that can be obtained, including:

  • Autonomy: Users do not need third-party assistance as they have full control over the deals made.
  • Cost savings: By using this technology, you no longer need to pay extra for the services of intermediaries, such as property agents, lawyers, and so on.
  • Efficiency: Its application can save time because it does not require managing physical documents and does not involve convoluted bureaucratic processes.
  • Trust: Documents that have been created will be stored securely in a shared ledger.
  • Security: This technology is relatively difficult to hack, especially if it is supported by a secure environment and complex cryptography.

On the other hand, the use of this technology still has a number of challenges in its application, especially in Indonesia. Adverse effects of its use include:

  • Contract transfer or unilateral execution may cause problems for the other party and affect the validity of the contract.
  • In the health sector, prescribing drugs can automatically shift the role of pharmaceutical business actors or doctors, and people other than doctors can freely provide diagnoses and prescriptions for drugs based solely on the data that enters the blockchain.
  • There are still no specific rules regarding the use of blockchain in Indonesia.
  • Lack of security audits run on the platform.
  • The absence of third parties, such as intermediaries and lawyers, often creates trust issues.
  • The number of transactions that the network can process per second is strictly limited. In addition, if the network traffic is full, the transaction process can take longer and be more expensive.

The future of smart contracts

Nick Szabo had foreseen the use of digital contracts that would replace physical contracts, citing that physical contracts tend to waste resources and take a lot of time. Now, the smart contract concept initiated by Szabo is predicted to be the key to revolutionizing various industrial sectors in the future.

It is certain that many companies will eventually adopt smart contracts in every transaction, especially with the promising technological innovations in the public blockchain space. The presence of this technology is a solution to revolutionizing complex systems that require the participation of many parties, resulting in efficiencies across enterprise systems. It’s no wonder that smart contracts are being hailed as the future of blockchain.

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