How Smart Contracts Work in Blockchain

Last Updated on May 10, 2023

The phrase “smart contract” has been bandied about frequently lately, not just in the context of cryptocurrencies but also in the corporate world.

This article will explain what a smart contract is, how it operates, why it’s crucial for blockchain technology and digital assets, and give some examples of smart contracts that have actually been utilised in the real world.

What is a Smart Contract?

In essence, smart contracts are automated contracts between the contract maker and the beneficiary. This agreement is encoded and baked into the blockchain, making it both irreversible and irrevocable. They are typically used to automate the implementation of an agreement so that all parties are immediately certain of the outcome and no middlemen are required. They can also automate a workflow so that it only begins when specific conditions are met.

Smart contracts were made popular by Ethereum (ETH), the second-most popular blockchain in the world, which has given rise to a variety of decentralised apps (DApps) and other use cases on the network.

Smart Contracts and Blockchain

Blockchain technology serves as the foundation for the idea of smart contracts.

A blockchain is a decentralised network made up of a continuously expanding list of records (blocks) connected by encryption. Unlike a traditional database, a blockchain network does not have a single central location. All of the computers that make up the network share the data that is stored in the blockchain. As a result, the network is less vulnerable to errors or assaults.

A record in one computer cannot be changed in a blockchain without also updating the identical record on other computers in the network. In a blockchain, transactions are organised into blocks that are connected by a chain. Only after the preceding block is finished is a new block formed. Each block comprises a cryptographic hash of the previous block and is presented in a linear chronological order.

How Smart Contracts Work

Smart contracts typically operate on the “If…/When…, then…” principle. In other words, a smart contract functions in accordance with clauses encoded as lines of code on a blockchain. When a linked action takes place, the computer network will function independently.

The first step is for the parties to agree on the terms and conditions of the contract. The steps of the transaction will then be shown in Programming Code after all of the circumstances have been translated.

As a condition statement, this is used. These codes will be kept on the blockchain, and data will be transmitted to network computer nodes so that users always have the most recent information and can follow each transaction’s development.

The blockchain network will update the data once it has been confirmed. The only people who can access any transactional information are other users of that specific platform, and it cannot be edited.

Read: All You Need To Know About Cryptocurrency

Benefits of Smart Contracts

As explained in the sections below, smart contract blockchains offer a number of advantages, including speed, efficiency, accuracy, trust, transparency, security, and savings.

Smart contracts automate tasks using computer protocols, reducing the number of hours needed for various business procedures. By removing the need for brokers or other middlemen to ratify the already signed legal contracts, the automated agreements lessen the chance of third-party manipulation.

Furthermore, smart contracts save money because there is no middleman involved. Additionally, the terms and conditions of these contracts are completely visible to and accessible to all relevant parties. Therefore, once the contract is signed, there is no way to cancel it. By doing this, it is made sure that the transaction is completely transparent to all participants.

Additionally, every document stored on the blockchain is duplicated numerous times, making it possible to recover originals in the event of data loss. Smart contracts are encrypted, and cryptography prevents tampering with all papers. Last but not least, they also get rid of mistakes brought about by manually filling out various forms.

Applications of Smart Contracts

The first cryptocurrency to use smart contracts was Bitcoin. At first, it was just employed for Bitcoin network transactions, but Vitalik Buterin, one of the developers, recognised the opportunity to create smart contracts. In order to implement smart contracts on his own platform, he built Ethereum in 2014. He released the source code as open source for everyone to use. This information is intended for other developers who want to use smart contracts and create them on their own platforms.

Smart contracts in finance

Smart contracts are used by developers to create agreements in financial transactions. Similar to the usual financial process, but without the involvement of outside parties like financial institutions.

Additionally, because smart contracts are self-executing, this creates a platform for decentralised finance that is accurate and trustworthy. The code that has been written and is accessible to all parties should be trusted by users rather than the developers.

Examples are:

  • MakerDAO has utilized smart contracts to create Dai, a stablecoin from crypto the collateral of the contract between users and the platform. 
  • Compound (Crypto lending platform) – Smart contract is used as a loan agreement between a user and the platform.

Smart contracts in investments

When it comes to tokenization, smart contracts provide “fractional ownership” investments in a number of assets. Blockchain technology helps to overcome a variety of restrictions in the world of investing.

Today’s digital world is home to many successful asset investment companies like RealT and SolidBlock. Investors can buy these projects with tokens thanks to these initiatives. Smart contracts also facilitate the contracting process. For instance, in Georgia, land title deeds were created using Blockchain in 2016.

Most notably, using smart contracts in asset investment will lower the cost of the land registration procedure and employ third parties, which are typically needed in the traditional method. This is because everything is already documented in smart contracts.

Smart contracts in law

Law is a fascinating area for a smart contract case study. Smart contracts provide the ability to communicate the terms and conditions to business partners. The most popular way to use it is through e-signatures. Another option that can lower the cost of engaging attorneys or other parties involved is using smart contracts.

Only a small number of US states have, however, approved the use of blockchain and smart contracts in the legal sector. Arizona has legalised smart contract contracts. Another option is to apply for a marriage licence utilising blockchain technology in California.

Smart Contracts in DAOs

Delaware in the US enacted Senate Bill 69 in 2017, enabling business owners to adopt blockchain. The legislation led to the creation of DAOs, which function as ownership-holding corporations and make use of smart contracts.

Smart contracts are used by DAOs to improve organisational structure. Due to the technology being able to award automatically, project expenditures are decreased. Renting a business, hiring additional divisions, and other expenses will all be less expensive.

Future of Smart Contracts

Unquestionably, smart requirements-powered contracts are the way of the future for relatively simple contracts that can be written and executed automatically whenever prerequisites are satisfied, like in residential conveyancing, where completion funds can be disbursed as soon as contracts are signed.

Different smart contract platforms will revolutionise how companies engage with their customers and in the supply chain while also saving them time and money around the world. Minimal human intervention will thereby liberate people and key decision-makers from dealing with tedious administration and red tape, allowing them to concentrate on their day jobs. It is a result of the smart contract picking up the slack.

Numerous banks and insurance companies currently employ smart contracts in their regular operations. Since they are already in use and being tested in actual situations, smart contracts will soon be a regular part of our daily activities. Despite the previous point, if ever, there will be a long way to go before everything is controlled by a smart contract.

Before you go…

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