There is much, much more to Bitcoin’s underlying protocol – the block chain – than is apparent at first glance. The digital currency could potentially change the way the world operates – and not just by challenging existing financial systems and decentralizing monetary transactions. Bitcoin evolved from the vision of enabling peer-to-peer transactions, without the need for a trusted third party. Block chain entrepreneurs are now taking this beyond financial transactions and leveraging the protocol for smart contracts as well.
A smart contract refers to a digital agreement that gets executed automatically when certain conditions are met, without the need of a third party, like a judge, to be the adjudicator. Smart contracts are typically self-enforcing as well as self-executing. To understand how the block chain protocol could be applied to smart contracts, you need to first understand the block chain in more detail.
Bitcoin is More than a Digital Currency
The protocol behind the Bitcoin network, the block chain protocol, is the foundation on which many entrepreneurs are building. The block chain is a general ledger that is maintained to keep a record of all the transactions that have ever been made. This is what ensures that every bitcoin is unique, as well as protects against security threats like double spending and the creation of fake bitcoins from the system.
A block is a record of a single transaction that occurs between two users, when one user sends bitcoins to another. This block contains a hash record of the block (or the transaction) that has occurred before it. The block chain database contains all these blocks inside it, built on top of each other. Essentially, no block can stand by itself – it always has a preceding block. Imagine a building under construction, if you would. A new floor, if it is to be constructed, needs a floor under it as a foundation. Also, each floor has a unique number that can’t be duplicated. This system makes it is impossible, or extremely impractical, to modify a block. Modifying a single block will mean having to modify each and every block that comes before it. As the block chain is present on every system in the Bitcoin network, any modification to a block (or if a new block is introduced) has to be run past all these countless other systems for validation.
This was, of course, a simplistic explanation of how Bitcoin transactions work. What it highlights though is that the block chain is essentially a transaction ledger that keeps a record of all bitcoin exchanges that have ever occurred. This same protocol can be used to track individual agreements between two parties or, in other words, for the storage and later execution of “smart” contracts.
The block chain introduces the desirable concept of minimal trust, as it almost completely removes the factor of human judgment (like courtrooms) from the process and so – it could be argued – makes the process fairer and more efficient. This can provide several benefits, apart from enabling self-execution and security. Contracts won’t be open to duplication or modification, for example – just like bitcoins can’t be duplicated or modified.
At present, smart contracts are still evolving, as detailed here. However, the concept is catching on fast. Like Bitcoin, smart contracts are here to stay. Expect to see more of them in the near future.