Smart contracts in Blockchain and how they work

This post will learn about smart contracts in Blockchain and how it works. Explained for beginners

What is a smart contract?

Smart contracts are essentially automated agreements between the creator of the contract and the recipient. Written in code, this agreement is embedded in the Blockchain, making it immutable and irreversible. They are often used to automate the execution of agreements so that all parties can be sure to conclude at the same time, without the need for intermediaries. They can also automate the workflow, starting when certain circumstances are met.

So what is an executed contract? A signed contract that establishes a contractual relationship between two or more parties is called an executed contract. Each party agrees to comply with the legal obligations that it has agreed to in the written agreement once the contract is duly signed. Popularized by the world’s second most popular Blockchain, Ethereum (ETH), smart contracts have led to a number of decentralized applications (DApps) and other network use cases.

One of the key advantages of blockchain networks is the automation of tasks that traditionally require an external intermediary. For example, the process can happen automatically, thanks to a smart contract Instead, the bank has to approve the transfer of funds from the client to the freelancer. All that is needed is for both parties to agree on a concept.

Another example might be a regulatory group and the citizens it represents debating the law. If the two parties agree on a blockchain-based system, the law would be enforced through a signed agreement. Perhaps users could read about the new law through the legal DApp or communicate with it in another blockchain-based way.

This article will educate readers about the history of smart contracts, how smart contracts work, and why smart contracts are important.

How do smart contracts work?

Think of smart contracts as digital “if-then” statements between two (or more) parties. If the needs of a group are met, then the agreement can be honored, and the contract is considered completed.

Let’s say the market demands 100 ears of corn from the farmers. The former will lock the funds into a smart contract that can be approved when the latter is delivered. When the farmer fulfills his obligation, the funds will be released immediately (ie after fulfillment of the legal contract). However, the contract is canceled and the funds are returned to the client if the farmer does not meet the deadline.

Of course, the above is a small use case. Smart contracts can be programmed to work for the masses, replacing government mandates and retail systems, among other benefits. Additionally, smart contracts would potentially eliminate the need to take certain disagreements to court, saving parties time and money.

This security is mainly due to the basic code of the smart contract. In Ethereum, for example, contracts are written in its Solidity programming language, which is Turing complete. This means that the rules and restrictions of smart contracts are built into the network code, and no bad actor can manipulate such rules. Ideally, these restrictions would mitigate fraud or covert changes to the contract. Cryptographic smart contracts can only come into force if all participants agree and sign on it. So he was set for life.

In more technical terms, the idea of ​​a smart contract can be broken down into several steps.
First, a smart contract requires an agreement between two or more parties. Once established, the two of you can agree on the terms under which the smart deal will be considered complete. The decision would be written into a smart contract, which is then encrypted and stored on a blockchain network.

Once the contract is completed, the transaction is recorded on the Blockchain like any other. All nodes will update their copy of the Blockchain with this transaction, updating the new “state” of the network.

You may be wondering if Bitcoin (BTC) and other networks can use smart contracts.
To some extent, yes. Every BTC transaction is a technically simplified version of a smart contract, and two-tier solutions like the Lightning Network have been developed to expand the functionality of the network. However, the use of Ethereum smart contracts is a special case.

Unlike most blockchain networks that are described as distributed ledgers, Ethereum is considered a distributed state machine, containing what is known as the Ethereum Virtual Machine (EVM). This machine state, of which all Ethereum nodes agree to keep a copy, is stored in a smart contract and the rules these contracts must follow. Because each node has rules built in to the code, all Ethereum smart contracts have the same restrictions.

In addition to the above, over 200 smart contracts were listed on the Cardano blockchain explorer ( ADA ) in September 2021. ADA smart contracts are implemented using Marlowe, Plutus, and Glow programming languages.

It is also important to note that smart contracts differ from written contracts in many ways, as explained in the table below:

The historical background of smart contracts

Believe it or not, smart contracts have preceded blockchain technology. While Ethereum, introduced in 2014, is the most popular implementation of the protocol, cryptographer Nick Szabo established the idea in the 1990s.

Szabo then conceptualized a digital currency called Bit Gold. Although the property was never actually launched, this predecessor to Bitcoin pointed to the use case for smart contracts: trustless transactions on the Internet. If Web 1.0 was the Internet itself and Web 2.0 the presence of centralized platforms, then Web 3.0 is a user-driven, trusted, automated version of digital space.

Many, including the Ethereum website, compare smart contracts to vending machines. Vending machines are used to ensure that the seller provides the product to the user, without the need for the actual person to take the money and deliver the item. Smart contracts serve the same purpose but are much more diverse.

Smart contracts have come a long way over time. They started out as simple if-then statements that a programmer could create and implement. However, those with limited programming knowledge centralize these “dodgy” contracts. Fortunately, these same developers are working to address accessibility issues.

From the beginning, developers have made it so that smart contracts can be made without coding knowledge. They increase security in a variety of programming languages, creating alternatives like secret contracts and designing ways to automatically store smart contract history in a human-readable format, much easier than using a blockchain to read.

Advantages of smart contracts

Smart Contract blockchains provide several benefits, including speed, efficiency, accuracy, trust, transparency, security, and savings, as explained in the following sections.

Smart contracts use computer protocols to automate operations, saving hours on a variety of business processes. Automated agreements reduce the possibility of third-party manipulation by eliminating the requirement for brokers or other intermediaries to ratify already signed legal agreements.

Also, the lack of middlemen in smart contracts saves money. Furthermore, all relevant parties have full visibility and access to the terms and conditions of these agreements. Therefore, there is no way to withdraw after signing the contract. This ensures that the transaction is completely transparent to all parties involved.

In addition, all documents stored on the Blockchain are duplicated many times, allowing the original to be returned in the event of data loss. Smart contracts are encrypted and cryptography protects all documents from unauthorized tampering. Finally, smart contracts also eliminate errors that occur due to the manual filling of various forms.

Where are smart contracts applied?

In addition to the payment example above, several potential implementations of smart contracts can automate the world and make it an easier place to live. Here are some prominent examples of smart contract use cases.

digital identity

There is monetary information on the Internet. Businesses benefit from knowing everyone’s interests, and people don’t always have control over how or benefit from that data. With smart contracts, people are in control.

In a blockchain-based future, identities will be tokenized. Ideally, this would mean that each person’s identity exists on a decentralized blockchain, safe and secure from all bad actors. Now, if the user wants to participate in social networks or submit documents to the bank for the purpose of the loan, he can benefit from the former and control the transaction process in the latter.

For social networks, no intermediary controls the network. Instead, users choose what information to make public and what private. If they want to participate in the exchange of information, such as backup, they can create a smart contract and choose what data will be transferred, instead of just taking everything about the user. A third party is not there to take some of the funds or secretly store and sell that information, only the user benefits.

The same goes for business with banks and other financial institutions. Communication involves only sending the necessary documents and vital information. There is no risk of the credit group storing your email address and selling it to other credit companies. This information is completely under the control of the user.

Real estate

In the traditional world, real estate brokers are a necessary evil. Since the act of selling a home is long and complicated, homeowners will hire a broker who will handle the confusing parts like paperwork and finding a buyer. While this may seem ideal for a retailer, remember that brokers charge a significant fee on top of the home’s sales price.

A smart contract can take the place of a broker, simplifying the home transfer process while ensuring it is as secure as with a broker. Here the nickname “suspicious” comes to the fore.

Imagine that the deed to your house is tokenized on the Ethereum blockchain. If you are willing to sell it, you would create a smart contract with the buyer. That contract would hold the work in escrow until the buyer’s funds are properly delivered. Then, and only then, will he be released?

Everybody wins. The seller saves money because he doesn’t have to pay the middleman, and the buyer gets the house much sooner than otherwise.

Sure

Insurance policies could easily benefit from smart contracts. The policy registry would essentially enter the user into a smart contract with the provider. All policy requirements would be written into a smart contract, which the user would read and sign if they agreed.

That contract would be open until the taxpayer needs it. They would then simply upload the required forms to prove their need to pay for insurance and release the funds. This type of contract eliminates the need to contact insurance groups and individuals. Although the user would still need documentation to prove their claims, the filing and subsequent funding process will be almost instantaneous.

As for the identity of things, it’s worth noting that all drivers will have a record of their accident reports and other important insurance information. This affordability could result in lower prices for good drivers with no trace in their driving history.

Supply chain

Probably one of the most popular implementations of blockchain technology and smart contracts is especially within the supply chain.

Grocery stores, office warehouses, farmers, and others have their specific place in the supply chain. But as these networks become more complex, companies are finding it increasingly difficult to track product storage and payments, among other things. Smart contracts can automate and encourage all parties in the supply chain to increase their responsibility.

For example, let’s say a grocery store is waiting for apples to be shipped from another continent. After taking over, he paid for a certain number of apples and expected that exact number. However, human error can have an effect. Somewhere along the way, the workers might snatch a few apples, steal them from the queue, or just lie that they had all reached their destination. One side that does this ruins the rest of the chain, and when the store receives its shipment, who knows where it went wrong.

With smart contracts, the store could set up an automated login at each step of the process. Although these applications already exist in the normal supply chain, they must be completed manually. The person may need to count the items and deliver what has arrived. They could lie and take part in the product, claiming that part was lost on the way. Supply chain theft is a huge problem,  costing  Americans $35 billion a year.

What is different about smart contracts is the non-trust aspect. The store could adjust this to not release the payment until all the apples have been settled. There is no way to cheat this system, so the parties will be much more careful when it comes to acquisitions. In addition, the payment will be immediately delivered to the recipient, which in itself is a great incentive.

Additionally, the store could monitor which smart contracts are not being honored and decide not to work with those parties. Lastly, there could be a whole network of testing clients that are best to work with and not to work with, saving time and money in the long run.

What are the main challenges facing smart contracts?

While smart contracts are great in concept, they are certainly not perfect. First of all, it is worth remembering that smart contracts and blockchain networks are programmed manually. Human error is always possible, and that error can lead to exploitation. This is exactly what happened with the Ethereum Decentralized Autonomous Organization (DAO) attack in 2016. Hackers exploited a vulnerability in the DAO smart fundraising contract and exploited it to use project funds covertly.

Not to mention the lack of regulatory clarity when it comes to these autonomous agreements. While the idea of ​​a secure and streamlined money transfer process sounds great on paper, taxes and other government commitments still need to be considered. Users may want full control over their data, but how do government parties get what they need?

Furthermore, smart contracts cannot extract information outside of the network in which they exist. At least not in its current state. In other words, you cannot transfer data from an existing website to a smart contract on Ethereum. Furthermore, there is a solution in the prophecies: unchained nodes that extract information from the Internet and make it compatible with blockchain networks. Over time, as databases move to the Blockchain, prophecies could step in to play a role in making that happen.

Also, there is a long-standing scalability issue. From the start, blockchain networks tend to have large-scale issues, meaning transactions can take minutes, if not hours, depending on activity. While this might be a problem at first, it is something that projects like Ethereum 2.0 want to solve. Furthermore, a transaction that takes several hours is still much faster than the days needed to transfer traditional funds.

The future of smart contracts

Requirement-based smart contracts are certainly a way forward for relatively basic contracts that can be written and executed automatically as long as preconditions are met, such as home transfer, where money from completion as soon as the contracts are signed.

Different smart contract platforms will save companies around the world time and money while revolutionizing the way they communicate in the supply chain and with their customers. As a result, minimal human involvement will free important decision-makers and individuals from dealing with day-to-day administration and bureaucracy, allowing them to focus on their day-to-day business. This is because a smart contract takes over.

Many banks and insurance organizations already use smart contracts in their daily operations. As a result, smart contracts are already here and being tested in real-world scenarios, and it won’t be long before they become part of our daily grinds and routines. Regardless of the argument above, there is still a long way to go until everything is regulated by a smart contract, if ever.