Understanding Smart Contracts

By iTrustCapitalMarch 23, 20223 minutes read
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Understanding Smart Contracts

Imagine closing a business deal or borrowing money without the involvement of any bank or outside agency. Is it possible? With smart contracts that operate on blockchain technology, you can transact without relying on a third party vendor.

Let's examine smart contracts more closely to better understand what they are and how they work.

What are smart contracts?

Whereas traditional contracts are documents composed of text, with terms that must be manually executed, smart contracts are lines of code that execute automatically when certain conditions are met in accordance with the terms written into the code. Smart contracts are stored on electronic ledgers that are publicly accessible.

Executing smart contracts is generally very efficient, with the lack of an intermediary increasing user autonomy. Smart contract data is encrypted to increase privacy and security. But user error with smart contracts can still occur, with the cost and time required to correct a smart contract being significantly higher than the cost of revising a traditional paper contract.

How smart contracts work 

A smart contract is “smart” because it recognizes when terms or conditions of an agreement have been satisfied, and proceeds to execute a specific agreed-upon action (or series of actions).

Imagine that a wholesaler wants to buy 200 bunches of bananas from a farmer. A smart contract can lock the agreed-upon payment into the smart contract. When the farmer delivers the bananas, the money is released immediately. If the farmer does not deliver the 200 bunches of bananas by a date specified in the smart contract, then the contract is automatically canceled. 

Smart contracts can execute automatically or be programmed to require additional authorizations from one or more parties. Once a smart contract is established, none of the parties involved can interfere or make changes to the contract without the knowledge of the other. Once the transaction is settled, the smart contract is automatically canceled. 

How smart contracts can be used

Smart contracts have uses that are many and varied. Here are just a few ways that smart contracts can be used:

  • Peer-to-peer transactions: Smart contracts can facilitate peer-to-peer exchanges of goods and services. Platforms supporting peer-to-peer transactions using smart contracts can create the contracts, set the contracts’ rules and conditions, and enable smart contracts to be used for many types of transactions.

  • Healthcare: Smart contracts can be used to store patients' health records, giving patients greater control over their own data and more privacy. Smart contracts can also automatically send proof of services rendered to insurance companies.

  • Government: Smart contract technology can digitally verify citizens’ identities, which can make voting more secure. Citizens can place votes with protection from the distributed ledger technology that underlies smart contracts.

  • Insurance: Smart contracts in the insurance industry can be used for documentation and claim processing, and to avoid fraudulent claims. 

  • Supply chain: Smart contracts can make supply chains more efficient by automating authorizations and payments, and increasing visibility throughout the supply chain. 

  • Non-fungible tokens: Smart contracts can be used to store non-fungible tokens (NFTs) and authenticate NFT ownership.

  • Decentralized finance: Smart contracts are being used to build fully automated decentralized finance applications.  

Other use cases for smart contracts continue to arise, including cases in the legal sector, traditional finance, and accounting.

The future of smart contracts

The concept of smart contracts originated in the early 1990s with Nick Szabo, an American computer scientist and cryptographer. Smart contracts were developed using Solidity, Ethereum's native programming language. Although the use of smart contracts is in its early stages, smart contracts are already being used in the cryptocurrency space. Alongside Ethereum, Binance Smart Chain, Polkadot, and Solana are a few notable crypto platforms that use smart contracts. Over time, other industries might even be able to leverage smart contracts to conduct everyday business.

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