Each of us has at least once used a vending machine, which gave us a drink, after throwing a coin and selecting your favorite drink. Legally speaking, this simple operation can be divided into three simple steps. Company owning the vending machine offered you for sale a drink in the machine. You accepted this offer by throwing the coin and pushing the button. Finally, the machine released your drink. You just concluded a smart contract.

What is smart contract?

Simply speaking, smart contracts are contracts which are not recorded as text, but rather in form of programming language. As opposed to traditional paper contracts, no further cooperation of the contracting parties is required. After meeting the pre-programmed conditions, the contract is automatically performed by computer. Using our example, after your acceptance of the offer (by throwing a coin and selecting a drink) the vending machine will automatically release your drink. Neither you or machine may then cancel or withdraw from the contract. Practically speaking, to return the drink into machine, although you have probably seen people kicking the machine which, for no reason, failed to release the drink for their money.

Generally speaking, it is actually the inability of the contracting parties to modify or cancel the contract which is essential rule of smart contracts. If this was not the case, smart contracts would not much differ from widely used e-contracts concluded on the internet. You are thus not concluding a smart contract by purchasing goods from your favorite eshop. Consumer laws usually allow you to unilaterally withdraw from the e-contract within prescribed period. This not the case of smart contracts. Once the smart contract is concluded and the pre-programmed conditions for its performance are met, neither contracting parties or any third party may not affect or stop the performance of the smart contract.

Blockchain and new era of smart contracts

Concept of automated contracts emerged in 1990s but became much more realistic only with arrival of blockchain technology.

How smart contracts work using blockchain technology? How you may send bitcoins from your e-wallet to your friend’s e-wallet? It’s simple. Each e-wallet has its public and private key. Your private key allows you to access your bitcoins stored in your e-wallet. You need address (so called public key) to allow you to send bitcoins from you to your friend’s e-wallet. In practice, you choose the amount, create a digital signature with details of transaction (your friend’s wallet address and number of bitcoins) using your private key. Transaction is ready.

To finalize the smart contract, you need to verify the transaction by millions of other computers connected to blockchain network. They will use your public key to verify your digital signature attached to the transaction. After verifying your transaction, the smart contract is concluded, and transaction is irrevocably recorded in blockchain. After this moment, you or your friend cannot change, cancel or withdraw from the smart contract which was performed automatically.

Will smart contracts replace traditional contracts?

Transactions with cryptocurrencies are just beginning. After two years of testing, first smart contract for sale of real estate was concluded and decentralized cadaster was recently established in Sweden. But blockchain technology brings opportunities for many other types of smart contracts. Scope of their use will mainly depend on the willingness of the authorities to accept and enforce smart contracts. More on this topic will follow.