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Smart contract

A smart contract is a computer program that automatically enforces its terms. Bankrate explains.

What is a smart contract?

A smart contract is a computer program that defines and enforces a set of conditions. Once a smart contract is deployed, its terms are virtually impossible to undo or alter, so every party to the contract can be assured they will get what they wanted. Businesses have begun embracing smart contracts because they offer greater protection from losses while giving customers peace of mind.

Deeper definition

When you sign a traditional legal contract, you’re agreeing to a set of terms and conditions backed up by the law and enforced by a civil justice system. If a party to a contract fails to honor its obligations, that’s called a breach of contract. Smart contracts make a breach of contract virtually impossible. Whereas a traditional contract describes the terms of a contract in plain language, smart contracts are written in code and don’t require the law to interpret their terms.

Once a smart contract’s conditions are met, its terms are enforced automatically using a blockchain, a digital, pseudonymous, public ledger that authenticates and permanently records every transaction. A blockchain is nearly impossible to hack or shut down. That makes safe and easy to do business with anyone, whether you trust that person or not. There is no way for the other party to back out of a deal after you’ve honored your obligations, and there is no point in the process when loss or fraud can occur.

Payment is made with a digital asset called cryptocurrency, like bitcoin. But smart contracts don’t have to involve money. Their terms and conditions are as simple as if-then constructions, so they can be used for such situations as confirming the terms of a divorce or the results of a surgery.

Ethereum may be the best known platform for smart contracts. Smart contracts on ethereum work a little like this: a user expecting a service from a business transfers a designated asset to the business. Then the smart contracts run, the service is rendered, and the transaction is validated on the blockchain. If the smart contract’s conditions are satisfied, the receiving entity gets to keep the asset. Otherwise, it’s refunded to the user.

Banks may start issuing mortgages that run on smart contracts. Use Bankrate’s comparison of mortgage rates to get informed.

Smart contract example

Thelma runs a driving school using the ethereum blockchain so information about every student’s lessons is recorded. Louise wants to learn to drive, so she puts 10 ether into a smart contract whose conditions state that 10 ether is required for a class. After Thelma teaches Louise to drive, the blockchain validates the transaction, and the smart contract automatically releases the 10 ether to Thelma.

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