How will you feel if you can complete Smart Contracts without hassles, paperwork, and intermediaries? Imagine that you can buy your car or a house without having to pass through some rigorous processes that will exhaust you from beginning to the end.
That’s what smart contracts do for you. It is one of the tools on the blockchain technology that ensures a smooth and stress-free transaction between different anonymous parties. Almost every transaction in the crypto space is completed in smart contracts.
So, if you’re looking for a simple but in-depth guide on what smart contracts are, this article is for you. We’ll look at every important facet of a smart contract to acquaint you with the concept.
Let’s dive right into it.
What are Smart Contracts?
Smart contracts are contracts on the blockchain technology that executes automatically at the completion of the terms and conditions. More simply, a smart contract ensures a smooth transaction between different parties without the need for a third-party or authority. They are lines of computer codes that developers store on blockchain to verify and facilitate the negotiation and performance of contracts digitally.
The good thing about smart contracts is that they don’t require any legal body to supervise or ensure performance. Once the developers set the terms of the agreement and the parties meet the conditions, these contracts will self-execute. You don’t have to pay any middleman, and you can say goodbye to all those conflicts and time you waste on completing a contract.
With a smart contract, the parties can easily trust each order regardless of the anonymous nature of the relationship. It is important to note that all the terms & conditions which parties reach on a smart contract are usually recorded in a blockchain.
A blockchain is a record-keeping technology that facilitates the operations of crypto networks such as Bitcoin, Ethereum, Litecoing, etc. It is a distributed and decentralized ledger that serves as a public database for storing transactions such as smart contracts. But before adding any transaction to the blockchain, a consensus protocol must validate it to prove that it is true. The records on the blockchain are usually encrypted to ensure additional security. So, once the contracting parties have accepted the set terms of a smart contract, the record is then stored on a blockchain to secure it in a transparent and easily accessible way.
Smart contracts are not a new phenomenon in the digital space. It emerged in 1994 when a cryptographer, Nick Szabo, thought out the idea of recording contracts in computer codes. According to him, the nature of the contracts will be such that activates automatically when the parties meet all the terms. Nick felt that if they could achieve such a method, there won’t be any need for third-parties such as the banks to complete a contract relationship.
The cryptographer spent years working on this idea and also wrote a book on it. But he couldn’t push through with it because, in those years, blockchain wasn’t existing. However, in 2009, Bitcoin used blockchain technology, thereby opening the doors to its possibilities. With its existence and proven capabilities, Vitalik Buterin founded Ethereum, which successfully brought the first smart contract that works.
How do Smart Contracts Work?
We will use a simple example of an everyday transaction to explain how smart contracts work. Let’s say that Adrian is selling his car to Peter, and they decide to form an agreement for the car sale on Ethereum blockchain through a smart contract. The smart contract will contain the agreement between Peter and Adrian. The terms of the agreement may be that when Peter pays a specific amount to Adrian, he becomes the car owner.
Once they record this agreement on the Blockchain, there’ll be no amendment or changes. Due to the nature of this smart contract, Peter won’t hesitate to pay the amount because the foundation of the contract is trustworthy and rock-solid.
In a situation where there’s no smart contract, these contracting parties will have to use third-parties such as a lawyer, a bank, a broker to complete the transaction. Also, they’ll have to pay some fees to these third-parties for employing their services. But with a smart contract, all those fees, delays, and arguments associated with negotiations will no longer be necessary.
There are other points to note about the working of smart contracts.
Smart contracts are interdependent
Smart contracts can indeed work independently, but sometimes, they’re interdependent on one another. For instance, developers can arrange the smart contracts so that as one contract expires, it triggers the next contract to start running and execute successfully.
This means that organizations can base their activities or transaction solely on smart contracts and complete them successfully. Also, different systems can also run on smart contracts, as we’ve seen in many cryptocurrency systems. Since the developers predefine the laws of operations on these systems, they can function independently and autonomously.
Every smart contract is in three parts
A smart contract comprises three objects or parts. There are the signatories, being the parties that want to use the contract. These are the people with the power to agree or disagree with the terms through digital signatures.
The second part of a smart contract is the main subject which the parties are either agreeing or disagreeing against. But note that the subject of a smart contract must be something existing in the environment. So, that way, the smart contract can have direct access to it. The issue of a subject matter for smart contracts was what delayed the execution of the concept way back in 1996. But when Bitcoin appeared in 2009, there became a viable subject matter for smart contracts to exist.
The third object of every smart contract is the “Terms.” Note that the terms of a smart contract must appear in a mathematical description with a programming language that suits the smart contract’s environment. The description will show the requirements which the contracting parties will meet and the rules which they must follow. It will also describe the punishment which a defaulting party will face for such an action.
Smart contracts need a suitable environment
For every smart contract to function as it should, it must operate within a suitable environment. Such an environment must support public-key cryptography. This will enable the use of cryptographic codes in signing off for such transactions. Almost every cryptocurrency existing now is using public-key cryptography so that users can easily use their codes.
A smart contract also needs an open & decentralized database. This database must run on autopilot, and the contracting parties must trust the database. Also, the environment must be decentralized to ensure the successful implementation of a smart contract. This is why smart contracts run on blockchains due to their open & decentralized nature.
The last point to note in the smart contract environment is that the digital data source for a smart contract must be reliable. To ensure such reliability, the source must have HTTPS, root SSL certificates, and other necessary secure-connection protocols which are popular and featured in many software these days.
The benefit of Using Smart Contracts
- Smart contracts are trustworthy
Due to the encryption of documents and the security surrounding the blockchain, it is difficult to lose any document. Also, there’s no need for anyone to trust anybody in a smart contract because the system is unbiased.
- The environment is highly secure
Smart contracts are not hackable. Developers use cryptography that no one can easily decode to reinforce the environments, and that’s what keeps the document safe.
- Smart contracts are autonomous
Parties to a smart contract usually have total control of the transaction. There’s no need for a third-party intermediary to facilitate the execution of the contract. As such, they can complete the contract without paying fees of any kind to any company.
- Smart contracts are efficient
One of the benefits of using a smart contract is because it saves time for the parties. Imagine the rigorous processes that contracting parties usually pass through on a normal contract outside the blockchain. Sometimes, there may be many documents to submit in different places, even before the signing of the contract and after the signing. But with smart contracts, all those steps will no longer be necessary.
Due to the nature of smart contracts, everything in the process is usually accurate. Filling documents manually usually leads to numerous mistakes. But when you’re using computer codes, the results are more exact than what is attainable in traditional contractual terms.
Possible Challenges of Using Smart Contracts
Even if smart contracts have more benefits to offer than the conventional method outside the blockchain, it still has some challenges. Some of the cons of smart contracts might include the following:
- Code mistakes
For a smart contract to be secure, the codes must be free from bugs. But it’s unfortunate that there has been some exploitation due to bugs’ presence in smart contract codes. In such cases, hackers made away with people’s money in smart contracts because they could easily exploit bugs.
- Regulation challenges
Smart contracts have raised a lot of concerns to the authorities regarding regulations and taxes. The whole idea of a digital contract is still very new, and the government is still arguing that there should be a form of regulation for the processes. Also, they’ve been making efforts to see how these contracts can be taxed.
Apart from these challenges, smart contracts are still very dependable and trustworthy, and the crypto community is hopeful that with time, these challenges will become a thing of the past. It’d easy to see that the main reason for these challenges is that the technology is still new. But as it keeps evolving, developers will discover measures to mitigate them.
How Smart Contracts Can Changes Processes
There are many areas or sectors where the application of smart contracts can improve processes.
Using smart contracts for voting can ensure a secure and reliable voting system that no one can easily compromise. The truth is that for anyone to hack the votes on a blockchain, they’ll need massive computing power to do that, which of course, no one has.
- Management processes
Using the blockchain ledger to execute and save management records will lead to trust and ensure a smooth flow of work processes. Also, blockchain-based communication will ensure transparency, accuracy, and automation. So, management can avoid costly mistakes stemming from a disorganized workflow by using blockchain technology.
A smart contract can enable an automobile insurance firm to operate efficiently. It could help them to charge a premium based on the conditions under which their customers are using their vehicles. The adoption of smart contracts in the industry could also lead to the development of a system that can easily detect the culprit in an automobile crash.
- Real Estate
Smart contracts eliminate the need for intermediaries in the negotiation and executing of contractual agreements. Also, it could save you money on adverts and other facilitating processes to ensure a successful contract.
The blockchain can add more security to the operations of those in the healthcare sector. They can encode and store patients’ records on the network and only grant access to only those who use them. Also, they can rely on the decentralized ledger to safeguard sensitive documents, research results, and other documents that require security.
Smart contracts have come to stay. The increasing adoption and application of blockchain technology are also contributing immensely to the use of the concept. The benefits of using smart contracts are numerous. It still has some challenges; the crypto community believes that time will take care of them. As more and more transactions are completed through smart contracts, the developers will also increase their efforts in mitigating the dangers.
As for now, some of the blockchains where anyone can process a smart contract includes Bitcoin, Side Chains, NXT, Ethereum, etc. So if you’re still thinking about whether to use smart contracts or not, we believe that this article has shown you how efficient and reliable they can be.