What is a smart contract and what is its role in the blockchain?

03/23/2022, 04:30 PM

What is a smart contract and what is its role in the blockchain?
What is a smart contract and what is its role in the blockchain?

Smart contracts are computer programs that execute certain actions if all pre-defined conditions are met. All information and actions from the smart contract are stored on the blockchain.

A smart contract is one of the most important factors in many blockchain-based ecosystems. Thanks to its self-executing ability, many believe it will be a major “tool” that will take over and facilitate many aspects of business in every major industry.

Smart contracts have the possibility to eliminate the need for manual contract drafting, as well as the participation of third parties in the conclusion of the contract.

In order to explain simply how a smart contract works, we will use the simplified example.

You’ve probably heard of “crowdfunding” platforms like Kickstarter. If you have a business idea for a product but do not have enough money to start a business, you can create your own profile (page) on that platform. There, you can present your business idea in detail, hoping people will recognize your project and donate certain amounts.

Let’s say you opened a page on that platform where you say that your goal is to raise 10.000$. In the campaign description, you point out that every person who donates the amount of 500$ will receive some kind of service or product in return.

The collected money will remain on the crowdfunding platform until the end of the campaign. If your campaign manages to collect 10.000$, the platform will forward the money directly to you.

However, if you don’t raise the amount, the platform will refund everyone who donated money for your project.

What does this process have to do with the smart contract?

Smart contracts are actually self-executing lines of code. They automatically perform an action once previously set conditions are met.

In the previous example, the condition is that campaign must collect 10.000$. The moment the milestone is reached, the platform sends the money to the campaign creator.

What is a smart contract?

A smart contract is a protocol or software that acts as an agreement between two or more parties. Smart contracts are powered by blockchain technology, which means that all data and actions from the contract are stored on the blockchain network, and publicly available.

Two columns that compare the features of smart contracts and traditional contracts.
The differences between a smart and a traditional contract.

How do smart contracts work?

Smart contracts operate on a simple principle; “if/when”... (a certain condition is met), “then” (the action is performed).

Before drawing up a smart contract, the parties involved try to define all the criteria and conditions that must be met in order for the contract to be executed and the transaction carried out.

Smart contracts can contain as many conditions as necessary for the action to be done in a way that will satisfy all users.

Along with the conditions, the smart contract must contain possible exceptions, as well as a framework for resolving potential disputes.

Once all points have been covered, the smart contract can be programmed and tested. If everything works, it can be deployed.

Once the smart contract executes the transaction, if verified it goes directly to the blockchain.

Once the data is updated on the blockchain network, it can no longer be changed. Smart contracts are most often associated with the Ethereum network, as most smart contracts are coded using the Solidity programming language (*Ethereum was created in Solidity programming language).

Besides Ethereum, there are other networks that use smart contracts like EOS, Neo, Tezos, Tron, Polkadot, and Algorand).

A brief example of drafting and implementing a smart contract

The developer creates a smart contract by writing a code that will clearly set out the rules that must be followed to execute the contract.

For example, the rule may be: Person A will send 5 ETH to Person B on May 4th 2023. Once the rules are defined, the developer will “send” the contract to the Ethereum network.

Once the smart contract is on the Ethereum network it will take effect. Thousands of computers from all around the world (computers that run Ethereum network) will have a copy of this smart contract.

The action will be executed exactly on May 4th in 2023. Until that date, no one can change the rules of the contract or claim 5 ETH because the code does not contain such activities.

Vector illustration of a smart contract.

Top 5 benefits of smart contracts

1. Accuracy and efficiency

Many contracts today are still compiled manually and that leaves a space for plenty of errors. Sensitive information like amounts of money, names, id can be written in the wrong way. Of course, they can be corrected, but it will take more time to finish the process. Since the smart contract is coded and executed only if all conditions are met, it makes the whole process more efficient and precise.

2. Trust and transparency

All terms and actions from smart contracts are encrypted, but fully visible and available only to the parties who have defined the terms and who are participating in the transaction. Once the smart contract is executed and the data is stored on the blockchain, there is no way to change the previously defined items.

3. Speed

Smart contracts are based on computer code and blockchain, while the execution process is automated. Process automation allows all transactions to be executed at high speed, which can save you time (e.g. you don’t have to go to lawyers and notaries multiple times).

4. Security

Every transaction on the blockchain network is encrypted, making it almost impossible to hack. Also, each record of a new transaction is linked to the previous one (chain of blocks), which means that a hacker would have to change the course of the entire chain to modify one transaction, which is impossible.

Due to high levels of protection, smart contracts are one of the most secure data elements on the Internet.

5. Money and time saving

Perhaps one of the most important advantages of smart contracts is that you don’t have to visit multiple places like a bank, a lawyer’s office, or a public notary office. Not only you can save money, but you can also save some time too.

Where can smart contracts be used?

Smart contracts have a wide application possibility, although they are most often mentioned in the context of transactions between parties.

For example, developers can use smart contracts to create decentralized applications or new tokens.

Possible areas of use and application of smart contracts

1. Supply chain management

Supply chains are large networks of individuals, organizations, resources, activities, and technologies involved in the creation and distribution of products.

In large networks like these, every process can be time-consuming, expensive, and ultimately inefficient.

Some of the biggest problems in supply chains include the inability to track real-time data easily. Making errors due to manual data entry can be very costly.

A system that would use blockchain-powered smart contracts could, for example, automatically settle pre-agreed payments (between manufacturers and suppliers) without the need to issue invoices, and manually executed transactions.

One of the recent examples of the application of the smart contract in the supply chain can be found in Spain. Startup Trazable, which specializes in food production, seeks to connect with suppliers through the sharing of information about products and distribution through smart contracts.

This could also help the end-user of the product since the consumer could have insight into the whole process and know everything about the product origin.

2. Using smart contracts in the real estate industry

The process of buying, selling, and transferring ownership of real estate is a stressful and risky business for all parties. The real estate industry is known for difficulties with property ownership, land size, etc.

In order to make the whole process of buying and selling more transparent, parties hire real estate agents and lawyers.

As you might expect, involving third parties in the process is costly and time-consuming.

With smart contract parties would benefit from two things; avoiding third parties, and documenting every information about the property on the blockchain, which ultimately will be helpful in case of a future sale.

Countries like Georgia and the United Arab Emirates began developing a blockchain land back in 2016.

3. Smart contracts in the financial sector

Finances are the sector where smart contracts have a wide application, specifically in decentralized finance.

Decentralized finance has gained great popularity in recent years.

Currently, there are many DeFi applications that run on smart contracts. For example, you can find DeFi apps that offer trading products, loan services, etc.

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