What is a smart contract?
Updated: Apr 14
Have you ever wondered what smart contracts are, who invented them, how they work, and why have they become so popular thanks to blockchain?
Let’s answer all these questions starting with a small introduction!
Introduction to smart contracts
The computer scientist Nick Szabo, for the first time during the 1990s, described smart contracts as “computerised transaction protocols that execute the terms of a contract”, a vending machine. He used the term “smart” to describe them because they are more functional than their “paper-mate”. For him, smart contracts were helpful tools that secure computer networks by combining protocols with user interfaces (UI) for contractual agreements.
Instead, for the crypto industry, smart contracts are programs or easily digital agreements enforced by rules predefined by computer code and run on a blockchain.
According to Investopedia, “A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network. The code controls the execution, and transactions are trackable and irreversible.”
The innovation implemented by smart contracts lies in permitting trusted transactions and agreements to be carried out among anonymous parties without the need for a central authority. They allow developers to build apps that utilize blockchain security, reliability, and accessibility while offering sophisticated peer-to-peer functionality, the so-called dApps or DeFi applications.
How do smart contracts work?
Code represents several conditional statements and works on an unlimited condition-based principle of IF-WHEN-THEN. Once these conditions are successfully met, the smart contracts will execute and validate a transaction.
We can summarize the operational process in 4 steps:
Each node stores a copy of all current states and transaction data.
When a smart contract receives funds from a user, its code is executed by all nodes in the network to reach a consensus about the outcome and the resulting flow of value.
To execute a smart contract on the main networks, you will generally have to pay a fee called “gas”.
Once deployed onto a blockchain, smart contracts can’t be altered, censored or shut down, even by their developers, unless a specific function provides that.
Below you can see a video that perfectly explains smart contracts through images.
What problems do smart contracts solve?
Efficiency, accuracy and speed – smart contracts are automated in the backend process; there’s no paperwork to process and manually correct as a document. No waste of time.
Transparency and trust – no third parties or intermediaries are involved, and the transaction records are shared across participants.
Security – Transaction records are encrypted. The smart contract runs on a decentralized blockchain, meaning there is no central point of failure to attack.
Savings – Without involving any middlemen, it can reduce transactional costs. Saving or sparing a lot of money.
Reliability – Having the contract logic processed and verified by a decentralized network of nodes provides solid tamper-proof guarantees that the smart contract will execute on time according to its terms.
Use cases and examples of smart contracts
As we have seen before, smart contracts have several benefits, including automatic execution, the ability to track transactions and the use of pseudonyms, thus ensuring privacy. But specifically, what are they for? What can you do with smart contracts?
create currency (stablecoins/tokens);
financial products (DeFi).
Smart contracts are used in several industries and sectors such as insurance supply chain, real estate, health systems, management, banking, government and charity.
Examples of blockchain platforms supporting smart contracts include Ethereum, EOS.IO, Cardano, Tezos, etc.
To summarize, the significant evolution in the blockchain industry is programmable smart contracts that connect emerging blockchain networks with today’s legacy systems, expanding the inputs and outputs used within smart contract logic. These are called hybrid smart contracts and use secure middleware known as an oracle to combine on-chain code with off-chain infrastructure.