To understand what smart contracts are, first of all you need to understand what a contract is. What is a contract? A contract is a binding agreement between two or more persons or parties, usually enforceable by the law. The roles of each individuals entering into the contract are well stated in the contract’s document and there is a legal side to it to make sure that the content of the contracts are upheld and not broken.
Now what is a “smart contract”?, Well a smart contract is a contract which is capable of executing or enforcing itself. Whereas a contract is written in legal language on a printed document, Smart contracts are written as programming code which can be run on a computer. This code can define strict rules and consequences in the same way that a traditional legal document would, stating the obligations, benefits and penalties which may be due to either party in various different circumstances. But unlike a traditional contract it can also take information as an input, process that information through the rules set out in the contract, and take any actions required of it as a result.
The main purpose of designing smart contracts is to enable people to trade and do business with strangers, usually over the internet, without the need for a large centralized authority site to act as a middleman. This is important because the main problem with shopping online, hiring people over the internet, and generally conducting business with strangers over the internet is the issue of trust. Most business requires some element of trust. For example, if I buy something at an online shop I am trusting that they will send it to me after I make a payment, and if they do send it to me they are trusting me not to reverse my credit card payment to take both the money and take the product for free. Up until now scenarios such as this have been solved by both parties going through large well-known sites which they both trust. For example, one of the great benefits of the internet is that it enables ordinary people to easily buy and sell things between each other – but the only way we have found to solve the problem of trust is for the vast majority of this peer-to-peer trade across the whole western world to go through a single gigantic virtual-monopoly website called eBay. Not only do these giant middleman sites charge significant fees for their service, they also impose their own limits and controls on what and how people trade, therefore severely limiting our business freedom.
By solving the problem of trust without the need for middlemen smart contracts can reduce business costs, reduce consumer prices, and increase our freedom to conduct our own business in whatever way we ourselves see fit.