How smart contracts work? It’s a question many people ask, especially if they are unfamiliar with the industry. Computer scientist Nick Szabo first proposed them in the 1990s, and they have since risen in popularity through blockchain technology, particularly Ethereum.
However, with the latest developments in blockchain and the rise of crypto exchanges and crypto debit cards like PlasBit, it became clear that smart contracts are more than just a new development that aims to satisfy tech geeks. Instead, they may become the future of the whole Web 3 business world.
Smart contracts are like self-operating programs that automatically run and execute the terms of a contract. These digital contracts run on blockchain technology and are tamper-proof and transparent, which is why many businesses look forward to them with much hope.
When conditions specified in the smart contract code are met, it carries out the agreement’s instructions without human intervention. Such a feature can dramatically reduce time and costs by eliminating go-betweens from processes requiring oversight.
These coded agreements are stored on blockchains and make transactions immutable and irreversible once executed. They trigger workflows without delay based on certain circumstances.
Originating with Ethereum, smart contracts have become integral to decentralized applications (DApps) across various industries, bringing about times when many can share resources over the internet.
History And Creation of Smart Contracts
Nick Szabo, a visionary cryptographer, brought smart contracts into the world in the 1990s. He saw the potential for automating contracts using computer programs and envisioned them as self-executing agreements with the terms directly written into code.
Szabo’s development was ahead of time back then, as the world was approaching Web 2.0 – the time of user-generated content and centralized networks. But sometimes, when the time is right, “old books” are reread. The Ethereum blockchain took Szabo’s concept to new heights after its launch in 2015. It became a foundational platform for decentralized applications (DApps) and revolutionized how contracts are made and executed online.
When leveraging Ethereum’s virtual machine (EVM), developers could create sophisticated programs that automatically execute transactions if certain conditions are met, pushing forward decentralized finance (DeFi) and opening doors for numerous industries to innovate securely on public blockchains.
How Smart Contracts Work In General?
But how smart contracts work is a ubiquitous question, especially when asked by people who haven’t had their hands on them. And it’s understandable. Thankfully, they are not all that hard to comprehend.
1. Identify parties and establish agreement terms.
Smart contracts start with clear identification of all involved parties. Once identified, these stakeholders agree on the contract terms.
- List all stakeholders: This involves naming everyone involved in the agreement, including buyers, sellers, lenders, and intermediaries.
- Determine stakeholder responsibilities: Define what each party is expected to do or deliver as part of the contract.
- Agree on payment terms: Establish how much and when the buyer will pay the seller or how funds will be split among parties.
- Set deadlines: Decide on specific dates for the delivery of goods, services, or payments.
- Outline conditions for fulfillment: Clearly define what conditions must be met for the contract to be complete.
- Include resolution methods for disputes: Determine how to resolve disagreements about contract details or execution.
- Ensure legal compliance: The agreement sticks to applicable laws and regulations governing the parties’ actions.
2. Define conditions for contract execution.
It’s crucial to define the conditions for contract execution. Such a step is needed to clarify all requirements before any code arrives.
- Set precise triggers for automated actions. The smart contract must specify what events will automatically initiate the performance of stipulated tasks.
- Outline obligations for each party involved. Participants should know what to do or avoid to fulfill the contract’s terms.
- Detail verification methods. Establish how tasks will be confirmed as completed within the blockchain system, using cryptography to ensure integrity and security.
- Specify time constraints. Include deadlines or specific dates when certain actions must occur to keep all parties on track.
- Determine transactional elements. Clearly define what digital currency, assets, or information will exchange hands upon fulfilling contract conditions.
- Incorporate dispute resolution mechanisms. In case of disagreement or failure to meet terms, detail how smart contracts provide decentralized arbitration without relying on traditional legal systems.
- Ensure compliance with regulations. To avoid legal complications, the contract must follow existing laws and regulations relevant to all parties’ jurisdictions.
- Layer in fallback provisions. Describe alternate outcomes if predefined conditions cannot exist due to unforeseen circumstances.
- Validate with consensus mechanisms. Confirm that every action taken under the contract adheres to the rules agreed upon by network participants within platforms like Ethereum Virtual Machine (EVM).
3. Write the smart contract code
Knowing how smart contracts work is valuable, but certainly, more is needed. Blockchain developers need to program the code so the whole system works.
- Identify the terms and parties involved in the agreement to be automated.
- Describe the conditions under which the contract will be performed, such as specific dates or trigger events.
- Code the smart contract using programming languages like Solidity for Ethereum or Chaincode for Hyperledger Fabric.
- Implement the code with proper syntax and logic to ensure accurate execution of the agreement.
- Include error handling and security measures to protect the contract from vulnerabilities and unauthorized access.
- Test the smart contract code thoroughly to identify and rectify potential issues before deployment.
- Deploy the smart contract on a suitable blockchain platform, ensuring compatibility with its requirements.
- Record all pertinent details of the smart contract on the blockchain ledger for transparency and immutability.
4. Deploy the contract on a blockchain platform
Contract deployment requires the following steps:
- Considering speed, security, and cost, choose the appropriate blockchain network for deploying the smart contract.
- Set up a digital wallet to hold the necessary cryptocurrency for paying the gas fees required to deploy the smart contract.
- Compile the smart contract code using specialized software or platforms designed for blockchain development.
- Connect to the chosen blockchain network using compatible tools and interfaces to facilitate the deployment of the smart contract.
- Execute the deployment transaction by submitting it to the blockchain network through a decentralized application (DApp) or command line interface.
- Confirm successful deployment by verifying the transaction on the blockchain explorer and ensuring that all associated details are recorded accurately on the distributed ledger.
- Test functionality of the deployed smart contracts. Developers can test various scenarios and interactions with other components of the blockchain ecosystem.
5. Automatic contract execution
Smart contracts enable automatic execution without intermediaries, significantly improving processes by cutting down intermediaries and reducing the risk of human error. Once predefined conditions are met, such as a payment being received or a specific date being reached, smart contracts autonomously execute the agreed-upon tasks and transactions.
By eliminating manual work, smart contracts optimize efficiency and trust in digital agreements.
By leveraging blockchain technology, smart contract details are securely recorded on an immutable ledger for transparency and accountability. This execution process is fundamental to realizing the full potential of smart contracts in revolutionizing various industries, from finance to supply chain management.
6. Record contract details on the blockchain ledger
After the automatic execution of a smart contract, all the relevant information has a record on a blockchain ledger. This process ensures that every aspect of the contract, including its terms and conditions, is securely stored and cannot be altered without proper authorization.
Recording these details on a blockchain ledger guarantees transparency and immutability, providing an indisputable record of the contract’s execution. Blockchain technology also makes 3rd party intermediaries obsolete, resulting in reduced costs and streamlined processes.
In essence, once a smart contract is executed automatically based on predefined conditions, its specific details are recorded on an immutable blockchain ledger. It provides transparency and security while eliminating third-party verification requirements.
Benefits of Smart Contracts
As with any technology, smart contracts aren’t ideal, but they might have multiple benefits if utilized properly.
Accuracy, speed, and efficiency
Smart contracts greatly enhance accuracy and efficiency by automating tasks that traditionally require a third-party intermediary. This decentralization of arbitration also saves time and cost, ramping up the speed and efficiency of the entire process.
Utilizing blockchain networks for smart contract deployment results in quicker decision-making and fund transfers, perpetuating heightened speed and efficiency.
The use of smart contracts not only diminishes counterparty risk but also provides increased transparency into various processes, boosting overall accuracy. By eliminating the necessity for third-party companies, commissions are reduced, leading to decreased delays in processing agreements.
These advantages yield enhanced operational efficiency across numerous workflows while enabling significant time savings.
Trust and transparency
Smart contracts promote trust and transparency by automating tasks traditionally handled by intermediaries. By executing agreements automatically on a blockchain platform, smart contracts ensure that all parties can view the terms and conditions, enhancing transparency.
Furthermore, the decentralized nature of smart contract arbitration promotes fairness in transactions, as disputes are resolved without relying on traditional legal systems.
In business dealings, smart contracts provide levels of transparency previously unattainable. The automation and immutability of these contracts give stakeholders more insight into processes and operations, fostering trust among parties involved in various transactions.
Security
Smart contracts deliver a supreme level of security in transactions thanks to their tamper-proof nature. They rely on blockchain technology, ensuring transparency and trust. Using Ethereum’s Solidity programming language strengthens the security of smart contracts, making them less vulnerable to cyber attacks.
Additionally, Ethereum’s distributed state machine feature further enhances the security of smart contracts by ensuring consistency across all network nodes.
Furthermore, smart contracts reduce counterparty risk and increase transactional efficiency while maintaining high levels of security. These programs are designed to automate agreements and execute actions based on predefined conditions, eliminating human error and manipulation.
Savings
Efficiency and automation from smart contracts reduce the need for costly fees from banks and lawyers. Customers can utilize crypto exchanges like PlasBit, just like banks, to safely store their funds and take advantage of Web 2.0/3.0 without sacrificing convenience. That is considered a smart financial move.
On the other hand, businesses can save time and money by reducing commissions and delays in processing agreements, leading to significant financial benefits.
Moreover, using smart contracts reduces costs associated with an intermediary’s involvement in transactions, making it a cost-effective solution for businesses across various industries. So, it’s a win-win situation for both the receiver and supplier.
Limitations of Smart Contracts
Smart contracts, albeit primarily reliable, still face limitations and challenges, including immutability once recorded on the blockchain ledger. It means that any errors or vulnerabilities in the code cannot be rectified after deployment, which could make them susceptible to exploitation.
Another challenge is the potential susceptibility to cyber attacks such as reentrancy attacks, transaction order dependence attacks, force-feeding attacks, and denial of service attacks due to vulnerabilities in the coding process.
Types of Smart Contracts
There are many types of smart contracts. However, we’ll take into account the main ones:
- Asset exchange contracts: They are used for transferring digital assets like cryptocurrencies and NFTs (blockchain art). Trading platforms, crypto marketplaces, and peer-to-peer transactions are their biggest “admirers.”
- Escrow contracts: Escrow contracts hold funds or assets until both parties meet the predefined conditions. They find a place in online marketplaces, real estate transactions, and cross-border trades.
- Insurance contracts: These contracts automate insurance claims processing and payouts. The most significant benefit of these contracts is that they streamline claims in the health, property, and vehicle insurance sectors.
- Voting contracts: Voting contracts store and tally votes in an election or decision-making process. They find applications in organizational voting, public polls, and community decision-making.
Loan contracts: Smart contracts can also automate loan payments and interest calculations, which makes them almost ideal for personal, educational, and mortgage loan management.
Smart Contract Use Cases and Applications
Knowing how smart contracts work is one thing, but tech enthusiasts aren’t the only people interested in that technology. More and more businesses seek ways to optimize workflows, collect payments more efficiently, and reduce taxes. But there’s more to the story, which we’ll discover in the following paragraphs.
Digital identity
Smart contracts have transformed digital identity verification processes by automating tasks that traditionally required a third-party intermediary. It enhances security and efficiency in establishing and verifying digital identities, which results in more reliable access to services while mitigating the risk of fraud.
When deploying smart contracts on the blockchain network, secure and transparent digital identity management is guaranteed, eradicating the need for centralized databases vulnerable to hacking.
Decentralized arbitration via smart contracts also provides a secure method for resolving disputes related to digital identities without relying on traditional legal systems. Smart contracts’ capability to automatically execute decisions when predefined conditions are met offers a trustworthy and verifiable approach to managing digital identities in various applications, from financial transactions to accessing online platforms securely.
Real estate
Smart contracts are revolutionizing real estate transactions by automating property ownership transfers, rental payments, and maintenance management. They facilitate straightforward property sales and rental agreements while providing secure escrow services.
The potential for smart contracts in real estate extends to applications in property investment agreements, lease management, and property insurance contracts, promising significant business and security advantages.
By recording all transaction details on a blockchain ledger, smart contracts ensure transparency and security, reducing the likelihood of fraud and disputes. While Ethereum remains the primary platform for real estate-related smart contracts, new ecosystems like the altcoins Solana and Cardano are also gaining traction among developers.
E-Commerce
The e-commerce industry is one of the biggest potential markets for smart contracts. Businesses already pay a large chunk of their net profit to payment processors, which can charge them outstanding fees, sometimes reaching more than 3%.
However, smart contracts help businesses connect with customers via crypto wallets for their transactions. They can easily save a good amount of money by integrating crypto transactions and, more importantly – reduce the risk of chargeback requests, which often plague the industry.
As for the customers, they can either pay with crypto or use a crypto debit card from premium providers like PlasBit, which are just like standard cards. Still, customers can purchase goods from DeFi products or regular stores, with crypto assets being exchanged in fiat currencies like USD or EUR immediately.
Insurance
Smart contracts find their place for various applications in the insurance industry. For instance, companies like Atlas Insurance and AXA have tested smart contracts to compensate airline customers in case of flight delays.
These digital agreements also create parametric insurance contracts that trigger payouts based on specific predefined events, such as crop insurance based on weather information.
Using smart contracts in the insurance sector allows for automated and transparent compensation processes, providing both parties with a secure and efficient way of managing claims and payouts.
Supply chain
Smart contracts play a substantial role in supply chain management, enhancing transparency and security while streamlining processes. They enable the automation of tasks such as payment release upon cargo arrival at its destination and confirmation from IoT sensors about optimal storage conditions.
Blockchain inclusion in the supply chain processes decreases the need for intermediaries and minimizes the risk of errors and fraud within supply chain operations. By recording each step on the blockchain ledger, smart contracts provide an immutable record of all confirmed and unconfirmed transactions, ensuring trust and accuracy throughout the process.
Implementing smart contracts in supply chains leads to greater efficiency, lower costs, and increased accountability among all involved parties. Their ability to execute predefined conditions automatically ensures that contractual terms are met without human intervention or delays caused by manual processing systems.
The Future of Smart Contracts
As technology development advances, the future of smart contracts is prosperous with potential. Trends suggest that smart contracts will become increasingly integrated with artificial intelligence, allowing for more complex and intelligent systems that can autonomously execute agreements and transactions.
Emerging blockchain platforms like Cardano and Solana are stepping up as new ecosystems for smart contract development, and they have become natural alternatives to Ethereum. With the ever-growing interest in decentralized finance (DeFi) and non-fungible tokens (NFTs), it is clear that smart contracts will play a fundamental role in shaping the future of various industries defining how digital assets are managed and exchanged.
Furthermore, the increasing adoption of Web3 technologies will further drive innovation in smart contracts. It will open up new use cases across different sectors, including supply chain management, intellectual property rights protection, automated business processes, and more.
As these developments unfold, it’s evident that smart contracts are poised to revolutionize traditional contractual relationships and create a new time where secure and transparent agreements can co-exist across global networks.
Conclusion
Knowing how smart contracts work is pivotal, especially for people interested in blockchain technologies. They automate agreements between parties by being coded and stored on the blockchain. As a result, these contracts eliminate intermediaries and can execute tasks based on specific circumstances.
Their immutable nature ensures the successful completion of agreements while saving time and costs for the involved parties. Smart contracts have the potential to revolutionize retail dealings and traditional legal systems, as they offer a transparent and efficient alternative for various industries, which could benefit from much better efficiency and, more importantly – an excellent way to cut down costs in the long term.
And since blockchains and cryptocurrencies cannot exist without each other, having a partner like PlasBit can be helpful for those who want to buy Ethereum and take full advantage of the DeFi economy, which is about to take over in the next few years.