What are Smart Contracts & How Do They Work?

If you are into things like tracking the Ethereum price or just interested in blockchain, you may have come across the term “Smart contract.” This piece of technology, which typically operates on the Ethereum blockchain, has come in handy to smoothen transactions and replace intermediaries that make things like land purchase tedious.

But what are smart contracts, how do they work, and what are their benefits? Today, we’ll take you through the basics of smart contracts.

What is a Smart Contract in Blockchain?

A smart contract is a small program stored on the blockchain. It contains agreements between two or more parties, and is executed when certain pre-set conditions are met. After the execution, the transactions contained in the smart contract are both irreversible, and trackable. This creates a high level of trust that eliminates the need for a central authority, legal system, or external enforcement mechanism.

Basically, you can think of a smart contract as the digital version of a traditional contract, but with a technological twist. While traditional contracts rely on legal documents and various enforcement mechanisms, smart contracts leverage the power of blockchain technology to automate the execution and enforcement of the pre-set terms.

How do Smart Contracts Work?

In their most basic form, smart contracts are much like “if…then” statements between two or more parties. If the requirements of one group are met, what they agreed on can be honored, making the contract complete.

As such, a smart contract has three important parts. The first is the agreement itself, which outlines the terms and conditions that the parties involved agree upon. Next, we have the predefined rules and conditions, which serve as the “if-then” statements to govern the execution and outcome of the agreement. There’s then the events that are executed when the conditions are met.

The contract is executed automatically when the conditions specified in the smart contract are met. For example, if a payment needs to be made for a certain task, the smart contract will do verification when the task has been completed, and the payment will then be made automatically.

After a smart contract is executed, the outcome is recorded on the blockchain. This automatically ensures transparency and immutability, as all the transactions involved become part of the permanent blockchain ledger.

Smart Contract Platforms

Blockchain technology is the base behind smart contracts. Ethereum, in particular, introduced the concept, and it is where most smart contracts are based. The blockchain is programmable, which allows developers to define the rules and conditions of their contracts using Ethereum’s Solidity programming language. It also gave rise to other revolutionizing industries such as decentralized finance (DeFi), non-fungible tokens (NFTs), and decentralized applications (DApps).

That said, Ethereum is not the only smart contract platform. Others include Hyperledger, Fabric, Corda, Polygon, and Solana.

What are the Benefits of Smart Contracts?

Smart contracts have quickly grown in popularity as they offer lots of benefits. These include:

• Speed, efficiency, and accuracy: When the pre-set conditions are met, a smart contract is automatically executed. It also doesn’t require human intervention, which eliminates errors.
• Trust and transparency: Since smart contracts use the blockchain, everything is decentralized to enhance trust, and it can’t be altered, as blockchain is immutable.
• Security & Reliability: All transactions on the blockchain use digital signatures and cryptographic encryption, which ensures that malicious actors can’t do any manipulations. The decentralization also ensures that there’s no single point of failure.
• Cost Savings: Smart contacts eliminate the need for intermediaries such as lawyers. Enforcement processes will also not be required, and these two effectively do away with overhead costs, paperwork, and administrative burdens.

These, among others, make the adoption of smart contracts continue to soar, especially in finance, supply chain, and real estate. And as organizations continue to recognize the potential of the technology, we can expect to see even more widespread adoption and the emergence of innovative use cases.