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What Is a Smart Contract? And What’s All the Fuss About?

Unless you’ve been squatting on a piece of land all your life, eating only what you could forage or hunt, you’ve signed a contract or ten.

Contracts are big business. Lawyers charge hundreds, thousands, even hundreds of thousands of dollars to create them. Then they charge even more to sue the other party when there’s a breach of the contract.

There are the judges, the clerks, all the paper, filing cabinets, and on and on.

The whole need for contracts is a lack of trust in the other party. The contract spells out what each side has to do to fulfill its obligation.

Smart contracts are going to change most of that, if not all of it. Paper contracts will be a thing of the past.

Man signing a paper contract, which will soon be replaced by a smart contractPaper contracts will go the way of the dodo bird. Source

What Is a Smart Contract?

According to Wikipedia, “a smart contract is a computer program or a transaction protocol intended to automatically execute, control or document legally relevant events and actions according to the terms of a contract or an agreement.”

I’m glad we could get that definition out of the way!

The Ethereum network, where smart contracts were first created, has this to say about them:

A “smart contract” is simply a program that runs on the Ethereum blockchain. It’s a collection of code (its functions) and data (its state) that resides at a specific address on the Ethereum blockchain.

Smart contracts are a type of Ethereum account. This means they have a balance and they can send transactions over the network. However they’re not controlled by a user, instead they are deployed to the network and run as programmed.

User accounts can then interact with a smart contract by submitting transactions that execute a function defined on the smart contract. Smart contracts can define rules, like a regular contract, and automatically enforce them via the code. Smart contracts cannot be deleted by default, and interactions with them are irreversible.

(Emphasis added.)

Things any clearer yet?

Some examples may help.

Car Insurance

You buy auto insurance from a company, which creates a smart contract between itself and you.

The contract resides on a blockchain, so the insurance company can’t decide later to change the policy, or deny a claim because someone’s having a bad day.

You’re involved in an accident. The police determine that it’s not your fault. An insurance adjuster visits the accident site, interviews you and the police, and enters all that information by mobile device into the insurance company’s database, which is connected to the blockchain.

The smart contract determines that you’re entitled to a claim, and the money is immediately paid to your account, or, more likely, paid to a repair shop when your car has been fixed.

Event Tickets

Your favorite band from the 70s or 80s is back on tour. You decide to go to a concert. You buy a ticket for hundreds of dollars. Unfortunately, two days before the concert, you land in the hospital and can’t attend.

You go online and resell your ticket.

In years past, you would have had to stand outside the concert venue and try to sell your ticket, which wouldn’t be practical if you were in the hospital. Or you could contact friends and family to help you sell it.

Recently, you’d simply go online and offer your ticket at whatever price you think it’s worth a few days before the sold-out concert.

Even with that process, you’d have to meet with the buyer, hand over the ticket, and hope that the person was honest and would hand over the agreed-upon amount of money.

The ticket you bought for $300 might be worth $500 to someone desperate to attend the concert. You meet up and, if all goes well, you’ve made a 67% return on your investment. The band gets none of the extra $200.

Soon, event tickets will simply be a QR code on your phone. You’ll go to the event venue, flash the QR code at a reader, and enter the venue.

That code is part of a smart contract. And that contract has certain stipulations. You’ll still be able to resell the $300 ticket for $500. But now, the band will get a cut from the amount you receive.

If you sell the ticket for $500, the band might receive $5, or $20, or 10%, or whatever the smart contract lays out.

And if the person you sold the ticket to turns around and sells it for $700, the band will receive another cut of the proceeds.

Event NFTs (Non-Fungible Tokens)

This, basically, is where event NFTs are headed. Each NFT is based entirely in a smart contract. Each NFT might even come with a digital representation of the ticket, so you can keep your “ticket stub” as a memento of the event.

Asset Tokenization

NFTs are also evolving into asset tokenization, also calledfractionalization. You’ll soon be able to buy a tiny share of an office building, or a housing development. Or a fraction of a share of Apple’s stock.

You can already buy a share of a vintage comic book or a rare car.

People will no longer need millions of dollars to invest in real estate, or tens of thousands to invest in the stock market.

They’ll be able to invest $100 in real estate and $100 in stocks, or buy a portion of a rare piece of art with $1,000. Or own a piece of the royalties earned by a song or movie.

Some professional athletes are already selling portions of their future earnings through a smart contract so they can have that income now.

They then use it to invest and earn even more. No more waiting a few years for the sports contract to pay them.

Decentralized Finance (DeFi)

This aspect of smart contracts has the world’s big banks and brokerages worried. It’s basically allowing people to “unbank” themselves.

Here are some of the things you’ll be able to do in the DeFi world:

  • Earn high interest rates (in some cases, 70X to 100X more than a bank’s savings account will pay you)
  • Lend money to or borrow it from others
  • Insure yourself or your belongings against risks
  • Speculate with futures contracts and other financial derivatives

This last one has evolved to the point where people are earning 20% to 100% or more on their money every year. It’s not without risk though. It also has a huge learning curve.

Called “yield farming” by some and “liquidity mining” by others, DeFi’s popularity has brought in scammers who create a platform, collect millions of dollars, and then do what’s called a rug pull, which comes from “pulling the rug out from under someone.”

Unless you’re a highly sophisticated investor, I recommend not getting involved in yield farming. And definitely don’t get involved until you’ve mastered the ins and outs of investing on these DeFi platforms.

The Future of Smart Contracts

As I mentioned earlier, contracts take the place of trust (for example, trust that a verbal agreement or a handshake is enough).

Smart contracts, which can’t be unilaterally changed, are ushering in an era of “trustless” transactions. What that means is that there will be no need to trust another person or a business or a government to do the right thing.

The smart contract code will do the right thing, at the right time, based on what’s written into the contract by the two the parties, or agreed to by the parties.

Whether it’s event tickets, or insurance, or earning high interest rates on your savings, smart contracts will be involved.

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