Smart Contracts in Blockchains: How they work

What is a smart contract?
Picture of Sreerag Pavithran
Sreerag Pavithran
Lead Product Developer

Initially introduced by computer scientist and cryptographer Nick Szabo in the 1990s, the intention behind smart contracts was to be a secure and efficient way to implement contract laws between transactors on the internet. Today smart contracts have evolved beyond their original intended purpose with a wide range of applications like identity verification, DeFi, DeFi gaming, NFTs, financial security, trade finance, governmental transparency, supply chain management, cross-border payments, and more. This article explores smart contracts, how they work, and why their ever-growing list of applications is transforming all industries.

What is a Smart Contract?

Smart contracts are programs coded on the blockchain network with a specific set of preset conditions that, when being met, trigger automated postconditions. The agreeing parties decide these prerequisites, and smart contracts act as the contract-coded embodiment of all the terms and conditions of the transaction. They cannot be interrupted, halted, or changed once they begin to execute.

Why do we need smart contracts?

Smart contracts are more than just a safe way to transact online. It is a new system that offers a secure, transparent, cheap, and effective solution to those willing to accept the modern-day paradigm shift toward decentralized finance. Here are some of the crucial aspects of smart contracts that have contributed to their desirability:

Security

Smart contracts are immutable programs securely housed on the decentralized blockchain network. This trustless feature implies that they cannot be subject to any form of change through hacks, coercion, or manipulation with malicious intent. Upon creation, smart contracts permanently replicate themselves across the numerous nodes or blocks on the blockchain. For a hacker to successfully modify or alter an entry, they would need to launch attacks on all nodes as there is no centralized weak spot to exploit. Hence, reducing the possibility of fraudulent actors counterfeiting or altering the smart contracts for personal gain.

Transparency

A Smart contract is fundamentally straightforward, transparent, and viewable on the blockchain network’s distributed ledger for stakeholders with clearance to view. It is transparent in its purpose, conditions, and outcomes and cannot be corrupted or coaxed to deviate from its goal. When creating smart contracts, it is worth knowing that their transparency level entirely depends on whether their purpose is to operate on a private or a public network. Public network smart contracts are visible completely to the general public, commonly engaging in the governance of Decentralized Autonomous Organizations (DAOs). On the other hand, businesses use private network smart contracts for increased operational transparency and efficiency within a select group of relevant stakeholders with clearance.

Removal of intermediaries

Traditionally, when you seek to transact with another party over the sale of property, goods, or others, there is often a need for an intermediary, witnesses, a notary, or a registered authority. With smart contracts, the need for third-party individuals is entirely unnecessary. The smart contract facilitates a direct transaction between the two parties with no need for exorbitant processing fees, such as when conventional banks facilitate the trade.

Decreased payment process time

Smart contracts are also popularly used to facilitate domestic and cross-border payments with an unmatched level of security and speed. They are not confined to the limitations of traditional banking, nor do they need the banking sector to process and facilitate transactions. These programs do not have down hours or banking holidays. Processing a smart contract is almost always instantaneous and sometimes has a short waiting period, which pales compared to the long waiting periods facing conventional banking transactions. Negligible payment processing periods are an excellent feature of smart contracts that benefits individuals and businesses.

How do smart contracts work?

To best understand how smart contracts work, let’s look at a case of a buyer who wishes to secure the purchase of a product from a seller. The two parties can codify the sale terms of the transaction using smart contracts, with specific instructions to transfer product ownership to the buyer upon completing the money transfer. Once the money arrives at the seller’s crypto wallet, the contract self-executes and transmits the ownership deed to the buyer. It is an entirely trust-free system that doesn’t require intermediaries.

The compatibility, interactiveness, and interoperability between smart contracts also allow business workflow automation efficiently without needing management intervention. This workflow automation method involves codifying a sequential series of smart contracts with different business actions to be executed depending on the failure or success of predefined tasks. As smart contracts are growing in popularity, blockchain adopters are discovering new and innovative use cases for the technology.

Examples of smart contracts

Business owners wishing to migrate to web3 can gain significantly from knowing how smart contracts can improve the efficiency of their core competencies. Here are some industries leveraging smart contracts to operate their businesses:

Decentralized Finance

A major disruptive force in centralized finance, DeFi dApps offers adopters a decentralized cheaper, transparent, and efficient form of finance that is unmatched by services provided by the banking sector. Powered by smart contracts, DeFi dApps are drawing numerous global customers for a more affordable and reliable form of money management that does not have unnecessary fees and complex processing formalities.

Play-to-earn Gaming

This revolutionary form of gaming is made possible by blockchain technology, NFTs, and smart contracts. It’s growing in popularity as a medium for users to log on and play recreational games to earn real-world money. It’s also being adopted by individuals in many developing countries as a stable source of income. DeFi games use smart contracts entirely for operating, market, and customer transactions. So whether you are making in-app purchases, cashing out your in-game earnings, or selling/buying your assets to other users, it would be good to know that no guarantors or intermediaries are charging you a fee for your transactions. Popular blockchain-based games such as Axie Infinity and Decentraland are market leaders that are functioning successfully with the use of smart contracts. These decentralized games additionally use smart contracts to guide their governance and growth. Through smart contracts, stakeholders and invested gamers vote on everyday decision-making, and different smart contracts are triggered depending on the voting result.

Ownership verification

Through tokenizing, unique ownership codes can be assigned to real-world physical objects and stored on the blockchain-distributed ledger. Smart contracts can compare the individual code inputs, verify if the code matches the ownership details recorded on the distributed ledger, and provide the verified results as output. This is a secure, quick, and effective way of proving the legitimacy of object ownership claims using smart contracts and blockchain.

Purchasing property

For decades, the real estate industry has depended heavily on intermediaries and third parties, such as brokers and bank representatives. Well, not anymore, as smart contracts are now used extensively in real estate to offer a more straightforward, effective, and cheaper option. For instance, if you are in the market to purchase a piece of real estate, you could directly transact with the seller and purchase the property through smart contracts and crypto.

Healthcare & Insurance

In 2021, healthcare provider Accellion FTA suffered from the most significant data breach in American history with a leak of roughly 3.5 million patients’ sensitive data. This incident left the healthcare industry needing a more secure patient data management system. Using blockchain and smart contracts, numerous healthcare and insurance providers now indirectly store patient data. Patient data is confidential and is therefore stored off-chain while being referenced on the blockchain as required. Hence, it cannot be subject to tampering or theft once recorded on the distributed ledger. Through this technology, patients can now establish an agreement with healthcare and insurance providers and grant data access when all relevant parties fulfil all the hard-coded prerequisites.

Logistics & Supply-chain

Supply chain management has adopted blockchain for its transparency. All organizational stakeholders can now track the movement of goods and inventory in real-time, using multiple smart contracts conditioned on the products delivered at a predefined location, time, and date. Successful delivery and details are permanently recorded on the blockchain network and notify all stakeholders before the next smart contract is triggered. Similarly, the logistics industry has adapted smart contracts for fleet tracking and management.

In conclusion, smart contracts are programs that are market-tested and proven to be valuable in countless ways. In the face of the inevitable migration of consumers and businesses from web2 to web3, it would be wise to check how you can benefit from integrating smart contracts into your systems and processes. If you still have doubts or don’t quite understand blockchain and smart contracts, Kreatorverse is a web3 design studio that specializes in all facets of smart contracts and may help shed some light on your blockchain doubts.

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