What Are Smart Contracts, and How Does It Work?

Smart contracts were initially suggested by an American computer scientist Nick Szabo in 1994. He is also famous for developing a virtual currency called Bit Gold. The purpose was to extend the electronic transaction method functionality to the digital assets field. Today, it has already become a reality. Smart contracts regulate most parts of people’s lives, including professional and personal. Many industries and businesses use them, and they have a crucial role in modern life development.

In this article, let’s see the main functions and benefits of smart contracts and how they revolutionize the technology world.

What Is a Smart Contract in Blockchain?

Smart contracts are lines or pieces of code that automatically execute when predetermined agreements and conditions between two or more parties are met. The agreements and codes are stored on a decentralized blockchain network. Moreover, the execution process is controlled by the smart contract’s code, which makes transactions irreversible, transparent, and trackable.

Smart contracts allow carrying out all the processes eliminating the involvement of third parties: external enforcement mechanisms, legal system, or central authority.

How Do Smart Contracts Work?

A smart contract is one of the crucial elements of many popular blockchain networks, for example, Ethereum.

Smart contracts usually pay attention to the simple “if/when…then” expression written on the code of a blockchain platform. Then, the execution process takes place via computer networks when specific conditions between the buyers and the sellers are already met. The process and actions can include such details as sending notifications, issuing a date, releasing funds to certain parties, etc. After the transaction is complete, the blockchain will be updated, which means only the parties who have permission can see the results.

The participants can add as many conditions and details as needed. They need to determine how their data and transaction should be represented on the blockchain platforms, explore all the exceptions, and define a specific framework for resolving potential disputes.

Many people compare a vending machine and a smart contract because, in both cases, there is no need for a real working person to take the money and give the product to users by hand. Everything is done automatically. Moreover, smart contracts continue to develop and become more advanced. With the help of different programming languages, developers try to increase the security level and make alternatives in case of any incidents. Today, it’s also possible to make a smart contract without writing complex code.

Benefits of Smart Contracts

A smart contract in blockchain provides many benefits and advantages to businesses implementing blockchain technology. These benefits are listed below.

Transparency, Reliability, and Accuracy

A smart contract makes the best use of the advantages of blockchain technologies for maintaining a verifiable record of all transactions and execution activities that can’t be changed after the process is complete. And the fact that a smart contract has a self-executing feature eliminates the possibility of human mistakes and ensures the transaction’s accuracy.

Processing Speed

The use of smart contracts deployed can also help to improve the overall speed of business operations and processes that run across multiple enterprises.

Savings and Cost Efficiency

Smart contracts’ automated nature helps businesses save resources and human personnel as there is no more necessity to monitor the complex execution progress. Moreover, the lack of other intermediaries helps to reduce costs and operational expenses.

Security and Protection

All the records of blockchain transactions are encrypted, and cryptography makes it difficult to hack them. Moreover, in case of data loss, it’s possible to restore the original forms of records as all the documents stored on the blockchain are duplicated several times.

Smart Contract Use Cases

Besides simple payment transactions, there are different implementations of smart contracts in various spheres and fields. Below are some of the most common samples of smart contract use cases.

Digital Identities

With blockchain technology and tokenized money, we will also have a digital identity in the near future: each user’s identity will be safe and secure and exist on a decentralized blockchain. On different platforms, people will be able to choose what data and information to make public or keep private. This also concerns information exchange processes, where companies will get a smart contract with available data and information instead of taking the full info about the user.

Finance and Banking

Decentralized Applications (dApps) can be an appalling alternative to traditional financial services. They offer options for banking and financial services, such as trading, borrowing, lending, and more. The banking industry may utilize smart contracts for new types of decentralized business models and products that can offer significant benefits to users.

Legal Industry

Blockchain technology is broadly used in the legal industry too. The innovations that smart contracts bring with them to this sphere are enormous. They include legally binding agreements and legal contracts that moved to another level due to the advent of e-signatures.

Real Estate Industry

As smart contracts are also used to identify and maintain property rights of digital assets, it has become easier to lower entry barriers for investment. Therefore, many real-estate companies implement blockchain technologies for their transactions. Smart contracts also change the processes of documentation and record-keeping.

Insurance

Insurance policies can also gain benefits from using a smart contract. All the policy requirements will be on the smart contract: clients would read the terms and directly sign them on the blockchain network. Afterward, they can simply upload the necessary forms for insurance payment and handle transactions by releasing funds.

Emerging Technology

The application of smart contracts doesn’t stop only on simple processes and transactions. It has already reached compounded computational tasks like artificial intelligence (AI) and machine learning. There is a potential to have an AI-powered contract in this field in the near future.

Blockchain and Crowdfunding

Smart contracts on Ethereum Network may be used for performing a transaction with the help of digital tokens. The user can issue and design any digital currency for different trade and payment services. Thus, the blockchain platform serves as a central bank issuing digital money.

A smart contract can also be useful in the crowdfunding sphere. You can build a contract on Ethereum and hold the contributors’ funds until the end of the funding process.

FAQ Section

What is a smart contract?

A smart contract is a self-executing code carrying all the agreements between the involved parties. It processes automatically after the predetermined deals are met.

What are smart contract use cases?

The number of contract use-cases is increasing drastically. Various industries and sectors have long implemented them for their business purposes. These areas include insurance, banking, real estate, cryptocurrencies, gaming, accounting, etc.

What are the benefits of using smart contracts?

You can gain multiple benefits after implementing smart contracts, including speed, accuracy, efficiency, transparency, and security of the transactions.

What challenges do smart contracts face?

Although the functionality and importance of digital contracts are already proven, there are several concerns and challenges this field still needs to face. The challenges cover long scalability issues, regulatory clarity, contract code vulnerabilities, and hacking attacks.

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