Smart contracts today are a hot topic of discussion in the digital landscape. Nick Szabo in 1995 introduced the world to the concept of smart contracts and how they could help automate our day-to-day transaction processes. After almost two decades, in 2015, a cryptocurrency researcher and programmer Vitalik Buterin launched the Ethereum blockchain that made smart contracts a reality.
As blockchain technology gains adoption, innovators are using smart contracts to disrupt operational processes across industries worldwide. Let us dive deeper and understand what is a smart contract and how it works?
Overview for Fast-Readers
— Smart contracts are lines of self-executing codes that help two or more parties transact digitally without a middleman.
— They are blockchain-based contracts and are hence decentralized, transparent, and immutable.
— Smart contracts can help make transactions in banking, trade finance, real estate, and other industries faster, cheaper, and more secure.
What is a Smart Contract
On the surface, smart contracts are digitized contracts hosted on a blockchain that help execute real-life transactions. Unlike real-life contracts, smart contracts store the terms of a transaction between two or more parties in the form of computer codes.
They are self-executing contracts. They do not need any human intervention to settle transactions between two or more parties. The term “smart” refers to the fact that these contracts can themselves assess when all terms of the contracts are met and only then execute and settle a transaction.
As immutable public ledgers, blockchains store all transactions executed through a smart contract transparently and securely, making the process more fool-proof and efficient.
How Smart Contracts Work
Simply put, smart contracts work on the “IF, THEN” logic of computer codes. Whenever a transaction request is triggered, a smart contract checks if the preliminary terms of the transaction, say the payment for a flight ticket, are met or not.
To do that, the smart contract extracts data from the real-world using special programs called oracles. If the data received tells the contract that the user has paid for the flight ticket, it executes the transaction which leads to the confirmation of the ticket, and the ticket details are sent to the user. In case the payment is not received or executed, the smart contract rejects the transaction.
These self-executing contracts are being used across many industries ranging from supply chain to finance, from gaming to healthcare, and so on. They make transactions processes faster, cheaper, and more secure by eliminating the need for middlemen or centralized systems in the transaction process.
While the concept of smart contracts may sound straightforward on the surface, coding a smart contract is an extremely difficult task. Even the slightest of mistake in the smart contract code may lead to its failure. Ill actors may then exploit the contract for their benefit.
Advantages of Smart Contracts
Decentralization and Transparency
Smart contracts are stored on a blockchain, which gives them the same properties as the blockchain. They are decentralized so they neither need any middlemen for the execution of the transactions nor can anyone alter the transaction based on their personal interests. All transactions are unbiased.
Blockchains are also transparent and store transactions on a shared ledger. Thus, any of the blockchain participants can easily track and trace the transactions that take place through a smart contract.
Speed and Cost Effectiveness
Be it making international payments or settling a real estate deal, the involvement of middlemen in a transaction makes it time and cost-intensive. Smart contracts negate the use of middlemen by automating these transactions. This makes the transaction settlement process significantly faster and cheaper.
Accuracy and Security
The codes of smart contracts once deployed cannot be changed. This is why it’s crucial for the coders of the smart contracts to code the terms of transactions precisely, without any ambiguity. These explicit details of codes of smart contracts make them highly accurate.
Smart contracts are also secure as blockchain offers them the highest grade of immutability. Once they are deployed, no central entity or individual can tamper with the code to manipulate the transactions.
Disadvantages of Smart Contracts
Exposure to Bugs
Immutability is the strongest advantage of a smart contract, but it is also its biggest disadvantage. Smart contracts programmers must focus on the smallest of details in their code. Even if a single line of their code leaves room for ambiguity, hackers may exploit the contracts to steal funds or alter transactions.
The issue is more critical because smart contracts are immutable and once deployed, no one has the authority to change anything about it. So far, there have been numerous such hacks where hackers exploited smart contracts and drained millions of dollars from faulty smart contracts.
What are Smart Contracts Used For
The trade finance industry relies heavily on manual processes and redundant documentation and redocumentation. Smart contracts and blockchain can streamline and automate the documentation and transaction process and save billions of dollars for trade finance companies annually. They can automate transactions and simultaneously record proof of the transactions in an immutable manner. This makes the process traceable and easily auditable.
Whether international or local, businesses around the world can schedule their payments using smart contracts so all their employees are paid on time. And as blockchain is a borderless technology, international transactions are extremely cheap and almost instantaneous.
Real estate transactions are both expensive and time taking. The involvement of middlemen looking to fill their own pockets makes the process all the more tiresome. Smart contracts can replace middlemen and automate real estate transactions. They can also reduce the chances of ownership frauds as all the transaction details will be recorded transparently on the blockchain.
Managing insurance claims is a time taking process, and it is also vulnerable to frauds and scams. The use of smart contracts for insurance claims can help make error checks easier. Based on this information, smart contracts can decide the amount that the insurance company needs to pay to the claimant. This can help Insurance companies mitigate the risks of false claims and make the process more efficient.
Smart contracts have immense use in today’s world. They are a complex technology on the ground level, but innovators are integrating smart contracts to platforms such that they can deliver seamless services without the users realizing that smart contracts are involved in the process.
They can replace many decades-old legacy systems we use due to the lack of better alternatives. While the mainstream paradigm shift is yet to happen, blockchain and smart contracts are slowly but successfully making their way into all our daily lives. And before we even realize, they may start serving us in the background of many applications we use.