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What Are Smart Contracts, And How Do They Work?

What are Smart Contracts, and how do they work?
Author: Rakshita Jain
12-Sep-2022

We all have heard of smartphones and smartwatches and even use them. However, do you know there exist smart "contracts" too that are slowly changing many things about us?

It looks like a thing to know, right?

So, let's become smarter by knowing everything about Smart contracts.

What are Smart Contracts?

Similar to the general contracts built on paper, Smart contracts are digital contracts stored inside a blockchain in the form of a program. They perform a task only when a specific condition meets.

Let's understand it with an example of an ATM.

Say you go to an ATM to withdraw cash. An ATM will give you money only once you meet a specific condition, i.e., inserting your card, pin code, and the value you want to withdraw. But, if you miss anything from these things, the ATM will not approve your cash withdrawal.

It is very much similar to how smart contracts in a blockchain work. They work as a humanless mediator between two parties and execute their request only when certain conditions meet. They do so by following the "if/when-then" rule, which states that IF/WHEN a specific requirement or condition is met, the Smart contract will execute the requested action.

Now, the next question that arises is how smart contracts work.

How do Smart contracts work?

A Smart contract works on the idea that "code is law". It implies that a smart contract will automatically execute the action if the conditions specified for its execution in the codes of a program are fulfilled. A person or entity is no longer needed to verify or perform an action because the smart contract does everything.

For example, let's assume two tokens, say 'A' and 'B', which are related to each other in such a way that the value of one 'A' token is equal to five 'B' tokens. Then you can build a Smart contract stating that if anyone gives you one 'A' token, you will provide them five 'B' tokens. This way, when anyone deposits 1 'A' token in your account, the smart contract will automatically verify this transaction. Once it ensures that the depositor has met all the conditions of your smart contracts, it will automatically send him 5 'B' tokens from your account.

Let's talk about document-based contracts when any party violates the terms of the document. The other party can take the necessary action against it. Whereas a smart contract ensures that all the parties follow the terms and conditions by not executing the result if the participants do not follow them. Since a computer code takes all the decisions in a smart contract without human intervention, there is no chance of humanitarian bias and corruption. The parties involved in the smart contract first read and understand it thoroughly, and only then do they participate.

Now, let's know where the story of smart contracts began.

History of Smart contracts

The idea of Smart contacts started in 1994 when an American computer scientist, Nick Szabo, coined the term "smart contract" for the first time. As per Wikipedia, Nick referred Smart contract as "a set of promises, specified in digital form, including protocols within which the parties perform on these promises".

However, the credit for popularizing smart contracts goes to Ethereum, which introduced the smart contracts in its blockchain to support the development of dApps. Bitcoin also supports smart contracts but possesses very limited programmability compared to Ethereum.

Ethereum not only has its smart contracts but also allows other programmers to build their smart contracts on it. Its Solidity language is made especially for this purpose. Moreover, the Smart contracts introduced by Ethereum also serve as the foundation for Defi applications and NFTs.

But a big question remains: Why should you trust codes instead of humans?

You will find out this below.

Why trust Smart contracts?

Here are the two biggest reasons to trust Smart contracts:

1. IMMUTABILITY
Since smart contracts are codes installed in an immutable blockchain, they also become immutable. It means once they get inside a blockchain, no one can change them for executing frauds, hacking, or other personal benefits. This quality of smart contracts makes them more trustable than humans or organizations that are very likely to get corrupt.

2. DISTRIBUTED
Every Smart contract is distributed, meaning no single person can influence it. This quality of Smart contracts eliminates the chances of discrepancies between parties that often arise in general contracts because one party holds more power than the other.

What are the benefits of Smart contracts?

  • Smart contracts eliminate the need to trust third parties because codes handle everything.

  • All blockchain information about a smart contract is available to its participants forever. Hence, it is highly transparent as compared to other alternatives.

  • Elimination of intermediaries brings automation into a blockchain through Smart contracts and directly reduces the cost of a project.

  • Smart contracts boost the process because the delay caused due to human intermediaries is no more, and the code works faster than humans.

Conclusion

Smart contacts are revolutionizing the blockchain industry swiftly. They bring automation to a system through codes, which increases its overall speed and efficiency. Many industries can benefit from incorporating smart contracts in their existing supply chain and other systems. It's just a matter of time before smart contracts will become a new normal for all thriving businesses.

 

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