People who are just starting to discover the world of cryptocurrency are often wondering if Bitcoin is using smart contracts. The answer is yes, because Bitcoin is literally a smart contracting platform. But first of all, we need to understand what smart contracts are and how they work.
In this article, you will find out what smart contracts are, their benefits, their utility and how you can use them to your advantage.
What is a smart contract?
A smart contract is a computerized protocol designed to facilitate, verify, or enforce the negotiation or performance of a digital contract. Smart contracts allow credible transactions without a third party. Basically, a smart contract is a digital agreement which is automatically executed and based on predefined criteria.
In 1994, Nick Szabo, a computer scientist and cryptographer, realized that the decentralized registry could be used for smart contracts, otherwise known as self-execution contracts, blockchain contracts, or digital contracts. In this format, contracts could be converted into a computer code, stored and reproduced on the system, and then monitored by the computer network running the blockchain. This would also lead to important activities such as transferring money and sending/ receiving a product or a service.
Nick Szabo wanted to create computerized transaction protocols that would correctly execute the terms of a contract or agreement. The purpose of such a protocol is to eliminate the need for the presence of an intermediary to negotiate, manage and support the contract between two parties.
Smart contracts can help you exchange money, property, shares or any other assets in a transparent way, while avoiding the services of an intermediary such as a lawyer. Moreover, smart contracts not only define the rules and penalties of an agreement in the same way as a traditional contract, but also automatically implement these obligations.
A smart contract is actually a program that runs on the blockchain. It includes both code and data, and it is never controlled by a user, but always operates according to its schedule. Therefore, such a protocol can inevitably manage transactions on its own, and does not require the presence of a third party in the relationship between the contractors.
Why do crypto users rely on smart contracts?
Any smart contract is registered on a blockchain network and has 2 important properties: it is immutable (cannot be modified) and distributed (any move must be validated by several users). These properties offer cryptocurrency users great confidence in the system.
Smart contracts eliminate the exceptions, accidents and losses resulting from fraud, because it is a code stored in a public database, available on all nodes of the network and, at the same time, cannot be changed in any way. Smart contracts can be extremely complex and include multiple conditional criteria, or they can be as simple as requiring a digital signature in order to spend money.
In technical terms, the idea of a smart contract can be divided into a few steps. First, a smart contract requires an agreement between two or more parties. Once established, the parties can agree on the conditions under which the contract will be considered completed. The decision would then be written in the smart contract, which is then encrypted and stored in the blockchain. Once the contract is completed, the transaction is recorded on the blockchain just like any other. Then all nodes will update their blockchain copy with this transaction.
Bitcoin’s scripting language enables a variety of smart contracts. The Bitcoin network functions as a giant distributed arbitrator enforcing the proper execution of smart contracts without relying on a single central authority. However, crypto users are mentioning a problem: all the terms of Bitcoin smart contracts are public for everybody. Yet, these smart contracts protect the real identities of the people who are using them.
On the other hand, the Ethereum network was designed and built for smart contracts. The term “smart contract” was often associated in particular with the Ethereum project, whose main purpose is to be a platform for smart contracts. Today, however, the term is used generically in the community to refer to any complex program that is stored and executed on the blockchain. Although there are many other crypto networks that have the same purpose, Ethereum still remains the most popular.
Where can you use smart contracts?
You can use smart contracts for all types of situations ranging from financial transactions to insurance premiums, breaches, property law, credit enforcement, financial services, lawsuits and crowdfunding agreements. Here are some examples:
The blockchain provides a single registry as a reliable source, but it also clears up possible communication and workflow problems due to its accuracy, transparency, and automated system. Typically, business operations must go back and forth, awaiting approvals and resolving internal or external issues. A blockchain registry makes this more efficient, as it provides confidence in data integrity, transparency and immutability. It also eliminates discrepancies that usually occur with independent processing that can lead to delays in resolution.
A smart contract could also be used in order to keep your medical file safe. Personal medical records could be encrypted and stored on the blockchain with a private key that would only allow access to certain people. The same strategy could be used to ensure that research is conducted through HIPAA laws (Health Insurance Portability and Accountability Act), in a secure and confidential manner. Operating receipts could be stored on a blockchain and automatically sent to insurance providers as proof of delivery. The registry could also be used for general healthcare management, such as medication surveillance, regulatory compliance, test results, and supplies management.
Grocery stores, warehouses and farms have their specific place in the supply chain. Nowadays, it is becoming increasingly difficult for companies to track product custody and payments, among other things. Smart contracts can automate and stimulate all parts of the supply chain to increase their accountability.
In addition to the major utility for trading in the blockchain, here are some other cases where a smart contract may be suitable:
- Trading activities
- Real estate market
- Data storage and archiving
- For mortgage or loans
- In the field of insurance
- To exercise the right to vote
- Copyright protection
The benefits of smart contracts
The most important benefits that smart contracts can offer are autonomy, trust, backup, security, speed, accuracy and the chance to help you save money.
- Autonomy – You are the one who concludes the agreement. This means that you don’t need to rely on a broker, a lawyer or any other intermediaries. In fact, this situation eliminates the danger of manipulation by a third party, as execution is handled automatically by the network.
- Trust – Your documents are encrypted on a shared registry. There is no way anyone can say they lost it.
- Transparency – Since all parties to the transaction have access to all the terms of the contract, there is full transparency.
- Backup – Your documents are duplicated many times.
- Security – Website encryption keeps your documents safe, so you don’t have to worry about hacking. Smart contracts use the highest level of data encryption available, which means that the level of protection offered is one of the best.
- Speed - Usually, you should spend a lot of time and handle many documents if you want to process documents manually. Smart contracts use software code to automate tasks. By doing so, it saves time and effort.
- Accuracy – Smart contracts are not only faster and cheaper, but also avoid errors that come from manually filling out forms.
- Savings – Smart contracts allow you to save money because they eliminate the presence of an intermediary.
How Bitcoin smart contracts work
The Bitcoin network allows users to create a wide range of smart contracts by using Script, a scripting language which controls how BTC is spent. Script is used almost exclusively to lock and unlock bitcoins. Script’s simplicity offers Bitcoin security and makes it easier for developers to avoid losing money while creating wallets or applications.
This scripting language allows people to establish their own criteria for their BTC to be spent. All Bitcoin transactions lock specific amounts of bitcoins to these scripts. A user must satisfy these criteria in order to spend the bitcoin locked to the script. In this way, all Bitcoin transactions become smart contracts.
Technically, each Bitcoin transaction is a simplified version of a smart contract. The Layer-2 solutions, such as the Lightning Network, have been especially developed to extend Bitcoin network functionality.
Every time a Bitcoin transaction occurs, the sender is claiming the ability to spend money and provides proof in the form of a digital signature. The receiver and all the participants on the network observe the transaction propagating through the Bitcoin network and verify that the digital signature is correct. Then, a miner takes the place of a central authority and “executes” the smart contract by including the transaction in a block and propagating it through the network. Finally, the receiver and the entire network need to verify the correctness of every signature in the block.
Smart contracts executed on the Bitcoin network still require trust in an arbitrator to execute properly, but the arbitrator is a distributed network of everyone cross checking everyone else.
Why use smart contracts
Smart contracts can optimize and automate a wide variety of transactions that take place in any professional sector. They can help companies build trust with their customers and also ensure maximum transaction transparency. And, most importantly, they are immutable, meaning they eliminate the risk of someone changing their contract to take advantage of others. These characteristics proved to be very valuable, especially in the financial sector and public administration.
Most smart contracts platforms will save time and money for companies around the world, also revolutionizing the way they interact in the supply chain and with their customers. In conclusion, minimal human involvement will help eliminate bureaucracy, allowing people to focus on their daily jobs.