What is a Smart Contract?

Smart Contract

Blockchains, the technology which sits underneath cryptocurrencies like Bitcoin are decentralized ledgers, held by a trustworthy source which tracks who owns what. Long after the Bitcoin hype has died down and the currency has settled at ‘normal’ levels, Blockchains are likely to remain and could underpin much of the high value transaction processing that currently only banks can perform.

Blockchains solve some of the most pressing issues associated with internet trades. Because they hold information securely on multiple computers in parallel they are hard to hack. Since they are decentralized, there are no middle men taking a cut simply for having the only machine that can conduct it. The system is far from perfect as it stands but it holds promise.

Blockchains also have facilities that current processing technology does not. The most useful of these are ‘smart contracts’.

Smart contracts can sit within Blockchains

Smart contracts are also known as ‘Self Executing Contracts.’ Blockchains are electronic in nature which offers the opportunity to build logic into them. Smart contracts are conditional terms which can be stored in many ledgers at once, as a series of rules and which will perform their task automatically.

Since, there can be multiple Blockchains, each storing different types and sorts of information, we might end up with a number of them, backed by institutions we trust (for example, the government) and combining to execute these smart contract agreements.

An example of how smart contracts might work in real life

Here’s an example of how a smart contract might work in this sort of environment.

Imagine buying your prepaid plan at the local supermarket. You explain what you want to the cashier. He or she takes your money, hits a few keys, confirms your identity with a driver’s license and provides you your prepaid pack.

Now, imagine the same transaction in a world with multiple Blockchains. Let’s assume the US Government has released a Blockchain, which it now uses to verify the identity of citizens. This USA Blockchain is backed by the administration so it is trust worthy and holds details of your social security, birth certificate, driver’s license and, if you’re married, a marriage certificate. For the purposes of this example, you want to buy a prepaid plan, so you’re filling in a form on the AT&T website, from your mobile phone.

The smart contract in the Blockchain behind the website simply waits, as computers will do, forever, until you provide 2 things.

  • First, a payment of $20 (the sticker price of the prepaid plan you’re buying.) For this component of the transaction, you use a proportion of your Bitcoin balance which is held in the Blockchain to pay for that.
  • Secondly you have to provide your ID for verification. The AT&T Blockchain contacts the government Blockchain which, since you’ve authorized it, confirms your ID for this purpose.

The process hasn’t changed. However, the variables involved are now provided once to a Blockchain, issued by a trusted source which stores them securely until you need it. The process no longer includes a cashier at a supermarket. The Blockchain itself conducts the transaction, issuing the prepaid SIM pack when the conditions required are met – here, when ID is provided and payment is made. The logic for the whole thing is built in to the Blockchain. You might also notice, there was no bank involved at all.

Why do we need Smart Contracts?


Smart contracts are clear, easy to build and manage, include no middlemen so they’re cheaper and are more efficient than the delays in payment processing which the banks now currently add. They’re not pie in the sky, either. Ripple, the world’s largest Blockchain can conduct smart contract agreements and is currently valued at $20 billion.

As we’ve said, however, Blockchains in their current form are not perfect. There is a cost in electricity to conduct transactions in Blockchain and it’s rising exponentially. Some estimates suggest that it costs around $150 USD in electricity (although the price of power varies around the world, 15c / KWh is a representative cost and it currently consumes 1000 KWh to transact over a blockchain.

That means that, while the prepaid example demonstrates the concept, it’s far more likely that only significant transactions like the purchase of a house will use Blockchains and smart contracts.

Blockchains hold a great deal of interest for banks, governments and other bodies which issue important, identity related information which is used again and again. They and smart contracts are likely to be the building blocks of future financial infrastructure.

Author Bio:

Neil AitkenNeil Aitken is the editor in chief for WhatPhone.com.au. He has worked on small business telephony solutions in the past and has written on the subject of telco trends, innovation and SIM Plans for Business Insider, The Sydney Morning Herald, Vodafone Australia and Savings Room, one of Australia’s leading blogs.

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Paschal Okafor is NaijaTechGuide Team Lead. The article What is a Smart Contract? was written by Paschal Okafor. The article was last modified: May 22nd, 2023
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