What is a Smart Contract?

Last Updated on December 24, 2023 by

A Simple Guide to Smart Contracts

If you’re a crypto trading enthusiast, you’ve definitely come across a digital asset named Ethereum.

While bitcoin is the gold standard for cryptocurrency, this digital coin is a close second when it comes to market capitalization.

Unlike other coins, however, Ethereum was mainly intended to facilitate smart contracts instead of being an alternative to fiat currency.

What is a smart contract?

What are smart contracts?

How do they work?

Do they have real-life applications?

Here’s the ultimate guide to smart contracts for beginners in 2021!

What Are Smart Contracts?

A Brief History of Smart Contracts…

Bitcoin may have been the first main application of blockchain technology, but since then, it has grown to accommodate many more digital assets, including smart contracts.

Contrary to popular beliefs, smart contracts aren’t recent and were first introduced in 1994 by Nick Szabo, a legal scholar. He later invented BitGold in 1998, which is why some conspiracy theorists often imply that he is Satoshi Nakamoto, the founder of bitcoin.

Szabo’s smart contracts were similar to what we have today. They were self-executing, supervised by other computers on a network, and could only perform tasks after they were converted into code.

This is the basis on which cryptocurrency smart contracts work.

Modern Smart Contracts Explained

Smart contracts are similar to other contracts in that they enable you to exchange property transparently, but they have a modern twist.

Instead of going through middlemen to execute the contracts, they use computer programming to verify, execute and enforce virtual transactions.

How Do Smart Contracts Work?

Vitalik Buterin, one of the main programmers of Ethereum, explained how smart contracts work in a very simple manner;

I. The currency or asset being traded is converted into a program.

II. The program conducts an evaluation to determine whether the asset should be transferred to the buyer or reverted to the original owner by running a code.

III. If all the predefined conditions are met, the transaction is completed, saving you lots of time and money while being fair to both parties.

Ordinarily, to execute a contract, you have to go through a third party, e.g. a lawyer. This process is highly time-consuming and expensive because there’s a lot of back and forth between the parties. Smart contracts streamline this process by eliminating middlemen.

Smart contracts work on an IF-WHEN-THEN principle. For instance…

IF/WHEN the buyer transfers the digital asset to the seller, THEN the buyer will pay the agreed sum of money. The terms and conditions that you can include in the smart contract are unlimited, and the transaction is only validated once the conditions are successfully met.

All smart contracts cant be deleted as they are stored in a decentralized ledger. This considerably reduces the chances of fraud as all parties can easily verify the information.

In a nutshell;

I. Two parties create a contract, but both remain anonymous.

II. Details of the contract are stored in a decentralized public ledger.

III. Events that will trigger the contract’s execution are set.

IV. The smart contract self executes once the conditions are met.

V. All activities can be analyzed and information verified by regulators.

Top Applications of Smart Contracts

Smart contracts have various real-world applications, including;

1. Trading Activities

Traditionally, all financial trading activities require a broker, and this lengthens the process and makes it more costly. Smart contacts eliminate all middlemen allowing you to trade more efficiently, reduce your costs and execute trades on time. This ultimately increases the liquidity of financial assets.

2. Mortgage System

Mortgage contracts are often complex, and there’s a lot of information being passed from the mortgagee and the owner. You also have to estimate the buyer’s credit information, earnings, expenditures, etc., which complicates the procedure.

Smart contract technology automatically handles all the necessary information in a transparent manner, allowing both parties to complete the deal digitally and without errors.

3. Employment Agreements

One of the main reasons employee-employer relations fail is that both parties are unaware of each other’s expectations. With smart contracts, companies can keep a record of all their

employment terms and conditions that they expect an employee to fulfil. This way, when the employees sign their contract, they are fully aware of their job description and work culture.

4. Records Storing

All smart contacts are stored as digital copies, and you can renew and release them as required. If the law requires a particular record to be permanently removed, they’ll automatically do that.

5. Real Estate Market

The digital nature of smart contracts eliminates the need for face-to-face meetings to finalize deals. You only have to provide accurate information about the property, its owner, the buyer, and their digital signatures. The information is then verified using identity tracking technology before the deal is executed.

6. Insurance Claims

The insurance claims process is not only very lengthy but also annoying to customers. There’s so much paperwork and formalities to be completed that claimants often get frustrated. With smart contracts, the entire process can be streamlined so that all conditions are automatically recognized and claims processed in an error-free manner.

7. Supply Chain Management

Smart contracts blockchain uses IoT sensors to track product movement from the collection of materials to product delivery. They also maintain records of lost items, late deliveries, and the concerned parties.

Main Benefits of Smart Contracts

Smart contracts are based on traditional processes, but they make them better. Some of the top advantages of using them are;

  1. Enhanced efficiency: they combine automation, speed, and accuracy to streamline processes in an error-free manner. They also eliminate middlemen, reducing the costs associated with contract execution.
  2. Guaranteed outcomes: all contracts are automatically executed as soon as the predefined conditions are met.
  3. Zero chances of miscommunication: all parties know what they are getting into because all information is available to them. This reduces communication gaps.
  4. No paperwork: the entire foundation of smart contracts is to execute agreements digitally. This eliminates the risk of losing paperwork as the records are safely stored.
  5. Total transparency: all concerned parties can access the smart contract and verify the set terms and conditions. If a change needs to be made, it has to be done before the contracts are ready. Once a smart contract is prepared, it can’t be deleted.
  6. Trustworthiness: the major challenge with manually executed contracts is that there’s a high chance of documents getting lost and information being manipulated. With smart contracts, all details are encrypted and stored in a decentralized ledger where they can’t be altered.

Drawbacks of Smart Contracts

The major drawbacks of smart contracts are;

  • The high levels of transparency come at a costly price; lack of confidentiality.
  • Smart contract technology is encrypted using code, and decoding can be difficult. If the programmers also make an error in the code, it could leave the users with loopholes.
  • If the wrong information is stored at the very beginning, the smart contract will be executed based on unreliable information.
  • Since smart contracts are stored digitally, if a hacker were to gain access to the database, they could execute rogue contracts.

Are You Ready to Embrace Paperless Technology?

Smart contracts are outsmarting traditional systems by executing agreements swiftly, affordably, and accurately. While they are just recently gaining popularity, they were first introduced in 1994.

Their applications in the real world are many, all of which are aimed at streamlining the process, enhancing transparency, and eliminating middlemen. This makes them applicable in industries such as healthcare, insurance, banking, real estate, and supply chain.

There have also been talks of integrating smart contracts in government processes.

The future of contracts is paperless, and this blockchain technology is taking us there.

Disclaimer: This article is intended to be used and must be used for informational purposes only. It's important to understand that digital assets are risky, you should always do your own research and analysis before making any material decisions related to any of the products or services described. This article is not intended as, and shall not be construed as, financial advice.