A smart contract is an agreement which will automatically fulfil and execute otherwise manual tasks which are part of an agreement, though the use of software code.
The concept originated in 1994 with legal scholar and cryptographer Nick Szabo, who realised that a decentralized ledger could be used for smart contracts, which are also known as self-executing contracts. In his model, contracts would be converted to computer code, and when a pre-programmed condition is triggered the smart contract would execute the corresponding contractual clause. However, Szabo’s concepts remained unrealised, until the development of bitcoin, and more important the driving technology behind the virtual currency – Blockchain.
Smart contracts are still evolving, and as such are not technically the same as a contractual agreement and as of yet are not legally enforceable. However, they can be used as support for contractual agreements and enforce functional implementation of a particular requirement is proof can be shown that the conditions were met. For example, if a car payment is not paid in time, the car could potentially be digitally locked until the payment is received.
Another analogy which demonstrates how a smart contract works is to compare it to a vending machine. If you want to buy a candy bar you could go and visit a physical store and talk to the cashier, exchange money and buy the candy bar. Alternatively you could go to the vending machine, insert your money and receive the candy bar. In the concept of smart contracts, the store represented the lawyers (or other third parties you would need to consult with to finalise the contract) and a smart contract is the vending machine whereby you insert a bitcoin and receive whatever document you were seeking direct to your account and fully executed.
An everyday concept of this smart contract model is Uber. The system is run through the application, and the contract as such begins when you indicate that you would like to be picked up from your location and taken to another. When the requirements of the Uber driver are meet and you are dropped at your destination, the contract automatically triggers payment of the amount for the service. Similarly, there is a requirement on the customer to not cancel the use of the service once the car is within a certain distance, and doing so will incur a charge, which is automatically charged from the moment you breach the requirement within the contract.
An example of how smart contracts could alter an everyday process is with online shopping. With the current system payment has to be made upfront, however under a smart contract the payment could be withheld until the goods are actually delivered, and once their part of the contract is fulfilled the payment is released to the sender.
The Ethereum network is a Blockchain program which allows for the programming of smart contracts, or the computer code which will facilitate or enforce a set of rules.