What Is a Smart Contract?

Smart contracts date back from the 1990sAt the time, smart contracts were described as a tool which defined and secured computer networks by blending protocols with user interfaces.

In the field of crypto, smart contracts could be defined as a program or protocol running on a blockchain. Generally, they function as a digital agreement or contract enforced by a specific set of rules and regulations. 

Those rules are established by computer codes which are reproduced and performed by network nodes. The moment the predetermined terms and conditions are fulfilled, the smart contracts are automatically executed.

However, smart contracts aren’t limited to cryptocurrencies. They could be implemented in a range of different fields that include contractual agreements — payment processing, content rights management, or credit systems.

Understanding Smart Contracts

Just like any other traditional contract, smart contracts help establish terms of agreements. However, what makes them “smart” is the terms are executed as codes running on a blockchain network, as opposed to those ordinary paper contracts. This allows developers to create apps that make use of blockchain reliability and security, while simultaneously providing delicate peer-to-peer functionality. 

Blockchain smart contracts deal with the creation and establishment of trustless protocols. Two parties that aren’t acquainted with or trust each other are able to make commitments through the blockchain. 

In the case conditions aren’t met, the contract won’t be valid and executed. Plus, the operational costs are considerably lower as there is no need for intermediaries.This is the fundamental idea behind cryptocurrencies — to make transactions without centralized intermediaries.

Even though Bitcoin started supporting smart contracts ages ago, it was Vitalik Buterin, the creator of Ethereum who made them popular. However, every blockchain network might have a different way of implementing smart contracts.

Source: Hubspot

The Importance of Smart Contracts

As previously mentioned, smart contracts enable developers to create a wide range of decentralized apps and tokens. They could be implemented in almost everything ranging from new financial tools to logistics and game experience. Just like any other cryptocurrency transaction, smart contracts are stored on a blockchain network. As soon as they are added to the blockchain, smart contracts can’t be altered or reversed.

Apps that are smart-contract powered are frequently called “decentralized applications” or “dapps”. They involve DeFi (decentralized finance) technology whose aim is to rethink and challenge the traditional banking industry. 

These apps enable token holders to participate in complicated financial transactions from any part of the globe without the interference of banks or other centralized institutions. Some of them encompass:

  • Uniswap — a decentralized exchange which lets clients trade particular crypto tokens through smart contracts with no central authority directing the exchange rates;
  • Compound — a platform implementing smart contracts to help investors accrue interest and borrowers instant loans without the interference of banks
  • USDC — a stablecoin (a type of crypto token) pinned to the USD through a smart contract, making it worth $1.

Now, how could you use these tools? Imagine that you have some ETH tokens in your possession that you seek to trade for USDC. You have an option to put some ETH on Uniswap that may employ smart contracts to automatically find the best exchange rate, perform the trade, then send you back your USDC. 

Next, you may put your USDC tokens into Compound, lend to other clients and get an algorithmically established interest rate. All this would be done with no bank or any other financial institution.  

Swapping currencies in traditional finance is costly, both in terms of money and time. Furthermore, it’s not easy or safe for holders to lend their assets to strangers across the world without government provided insurance and with murky regulatory and legal jurisdictions. However, smart contracts provide mechanisms making transactions such as these, and others, feasible and frictionless. 

How Smart Contracts Work

Nick Szabo, the first to mention smart contracts, compared them to a vending machine. So, picture a machine that sells soda cans for a quarter. You insert $1 in the machine and pick your favorite drink. The machine is programmed to either give you your beverage and 75 cents in change, or, in case your choice is unavailable, ask you to choose another, or even return $1 to you.

This is the most straightforward example of a smart contract. Much like a vending machine that automates a sale with no intermediaries, smart contracts could automate merely any sort of exchange. 

Presently, Ethereum is the most well-known smart contract platform. Yet, this doesn’t mean that other crypto blockchains — Polkadot, Tron, Neo, Algorand, Tezos, and EOS, to name a few — can’t run them. Anyone can create a smart contract and deploy it to a blockchain. The code is transparent and openly verifiable, implying that anyone can see the logic that a smart contract follows when receiving digital assets.

To write smart contracts, a range of different programming languages are used (including but not limited to Michaleson, Solidity, and Web Assembly). On the Ethereum network, every code is stored on the blockchain, so that each interested party could inspect it and its state, and verify its functionality.   

A copy of all existent smart contracts, together with their present state, blockchain and transaction data, is stored on a node, i.e., a computer on the network. Whenever a smart contract gets funds from a client, all nodes on the network execute its code to attain the consensus regarding the outcome and flow of value. This is precisely what enables smart contracts to run safely without any central authority, even during complicated financial transactions. 

As soon as a smart contract is deployed on a blockchain network, no one could change or transform them — not even their maker. This ensures that they aren’t censored or shut down. However, there might be some exceptions to this rule.

In order to execute a smart contract, you may need to pay a fee referred to as “gas.” These fees help the blockchain network run. 

Source: Futurist Speaker

The Bottom Line   

A smart contract represents a digital contract stored on a blockchain network and which is immediately executed the moment when predefined terms and conditions are fulfilled. Smart contracts are implemented to automate the execution of an agreement in order for all parties to be familiar with and certain of the outcome, without the need for intermediaries. Smart contracts are also able to automate a workflow, starting the following actions whenever conditions are fulfilled. 

Given the fact that smart contracts are digital and automated, clients are spared from wasting their precious time on paperwork or on correcting mistakes that might be found on manually filled documents.

Since there are no third parties or intermediaries, and all transactions are recorded and shared among participants, there is no fear that information could be changed for personal benefit. All records are encrypted, making them extremely hard to hack. 

With smart contracts, there is no need for intermediaries such as central banks or other financial institutions that would handle transactions. Due to this, there are no delays or high fees.

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