A smart contract, or crypto contract, is a self-executing digital contract that resides on the blockchain. The contract is converted to a piece of code, and the terms are automatically executed once the defined conditions are met and verified by the network.
It sounds more complicated than it actually is. Imagine an inventor who needs to find backers for a new product he wants to bring to market, but he doesn’t have a way to promote his invention or collect money from interested investors. He goes through a platform such as Kickstarter and sets up a campaign for $100,000. In exchange for a cut of the cash, Kickstarter promotes the campaign, collects and holds the money, and if the goal is reached, pays it to the inventor. If it isn’t met, it refunds the money to the backers.
The role of Kickstarter could easily be replaced by a smart contract with the same conditions.
There are four main advantages to smart contracts:
- They are distributed, which means that the outcome of the contract is verified by and visible to everyone on the network. Smart contracts are virtually tamper-proof.
- They are immutable, meaning that once created, they cannot be changed.
- They save money by removing the need for a third-party intermediary, such as Kickstarter in the example above.
- They are virtually unlimited in what they can do, as long as you can find a programmer to write the code to execute it.
A few blockchains currently support smart contracts, but Ethereum is the most well-known. In fact, Ethereum was developed exactly for the purpose of supporting smart contracts. Bitcoin also processes Bitcoin smart contract transactions but has less flexibility outside that. NXT is a public blockchain that has a limited selection of smart contract templates, but you cannot program your own if you don’t see what you want.
ICOs are another common use for smart contracts on Ethereum’s network. ICOs are related to IPOs, except that where IPOs are centralized and investment bank-driven, ICOs are decentralized and crowd-driven.