Definition

smart contract

This definition is part of our Essential Guide: Understanding blockchain: Tutorial for CIOs

A smart contract, also known as a cryptocontract, is a computer program that directly controls the transfer of digital currencies or assets between parties under certain conditions. A smart contract not only defines the rules and penalties around an agreement in the same way that a traditional contract does, but it can also automatically enforce those obligations. It does this by taking in information as input, assigning value to that input through the rules set out in the contract, and executing the actions required by those contractual clauses – for example, determining whether an asset should go to one person or returned to the other person from whom the asset originated. These contracts are stored on blockchain technology, a decentralized ledger that also underpins bitcoin and other cryptocurrencies. Blockchain is ideal for storing smart contracts because of the technology's security and immutability.

Smart contracts are complex and their potential goes beyond the simple transfer of assets, being able to execute transactions in a wide range of fields, from legal processes to insurance premiums to crowdfunding agreements to financial derivatives. Smart contracts have the potential to disintermediate the legal and financial fields, in particular, simplifying and automating routine and repetitive processes for which people currently pay lawyers and banks sizable fees to perform. The role of lawyers could also shift in the future as smart contracts gain traction, for example from adjudicating traditional contracts to producing customizable smart contract templates. Additionally, smart contracts' ability not only to automate processes but also to control behavior, as well as their potential in real-time auditing and risk assessments, can be beneficial to compliance.

The notion of smart contracts was invented by Nick Szabo, a legal scholar and cryptographer known for laying the groundwork for digital currency, in 1994. Back then, there was little interest or activity using the idea of smart contracts because there was no digital platform that could support them. Today, with the growing adoption of bitcoin and the support of blockchain technologies such as Ethereum, smart contracts are growing in popularity, often built on top digital currencies to trigger payments.

This was last updated in May 2016

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