Blockchain-based smart contracts have generated ample buzz recently as they could eventually build entirely autonomous organizations, enable self-regulated peer-to-peer insurance models, and facilitate the renting of all internet-connected things. This article explores how smart contracts work. It provides a brief primer on smart contracts, then compares the coding, storage and execution of smart contracts on Bitcoin and Ethereum, the two permissionless blockchain protocols that have achieved scale thus far. While plenty of healthy skepticism still exists around smart contracts, ARK Invest believes Bitcoin and Ethereum will be instrumental in validating the potential of this budding innovation.

Primer on Smart Contracts

A smart contract refers to coded logic that moves digital assets when triggered by necessary events. It is akin to a series of “IF, THEN” statements, where the “ifs” are preconditions that must be met in order to trigger the “thens.” The idea fits well within blockchain technology because blockchains offer a guarantee of future execution, in a decentralized manner,[1] once the smart contract logic is stamped within a block.

The term “smart contracts” often puts mental imagery of complex documents in peoples’ minds, which ARK believes is misleading.  This misconception explains why Mike Hearn, an early pioneer within the Bitcoin space, called smart contracts a misnomer in a November 2013 conversation on the matter. While he preferred the term conditional payments, ARK prefers broadening the term to conditional transactions to capture the idea that this technology can facilitate more than the transfer of money for goods and services.

Conditional transactions executed via a blockchain are computationally expensive because every computer that is part of the network needs to execute the same logic and update the state of the blockchain. In other words, each time a smart contract is triggered every computer has to perform the same task, consuming considerable resources and making the process inefficient when compared to parallel processing architectures. Therefore, not every conditional transaction will be appropriate for execution via a blockchain, but rather only those use cases that demand the distributed and secure nature of a shared ledger. Once more sophisticated solutions are implemented — like sharding, which can help to better parallelize computing tasks and storage — conditional transactions may prove less computationally expensive to the network, further widening the scope of applications.

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