If a blockchain can facilitate peer-to-peer transactions without a central authority, the same can be done for contracts: Two people can agree upon something and enforce it with cryptography.
This is the essence of smart contracts.
What Are Smart Contracts?
Morgan begins by describing how contracts work in traditional private law. A simple example would go like this: Legal Person A and Legal Person B have an attorney draw up a document that says A will perform X task for B in exchange for Y amount of money.
The problem here is two-fold. First, enforcement of that contract, should a dispute arise, becomes the responsibility of a third party, usually a judge. Criticisms of centralized financial structures apply here to centralized legal structures.
Second, there are costs in resolving a dispute. This includes legal fees, opportunity costs, and the straight-up mental and emotional costs of fighting someone over money. That’s what Morgan means when she describes people as often using traditional contracts as “swords.”
To swipe her example: Under such a contract, if I owe you US$10,000 but only pay you US$8,000, you have to calculate whether it is actually worth it to go after the remaining US$2,000.
Smart contracts solve that problem.
“Once a clause is coded into the blockchain, once that is in executable format, it will execute,” Morgan says.
With smart contracts, that US$10,000 is already secured on the blockchain.
“So, you can’t negotiate midstream.”