What is a Smart Contract?

Smart contracts have revolutionised the way transactions and agreements are executed in the digital world. Unlike traditional agreements, smart contracts run on blockchain technology, making them far more safe, efficient, and cost-effective.

If you’d like to learn more about smart contracts and see if they can be beneficial to you, keep on reading as in this article, we’re going to cover:

• How smart contracts work
• The 4 key features of smart contracts
• The 5 main benefits of smart contracts
• Common use cases of smart contracts

But before we go into any more detail on the topics above, we’d first like to help you understand smart contracts and why they matter.

Understanding Smart Contracts in Simple Terms

In most simple terms, smart contracts are self-executing digital contracts that automatically carry out the terms of an agreement when certain conditions are met. Think of a smart contract as a digital vending machine.

Once you put in the right amount of money (the condition), the vending machine (the contract) automatically delivers the product (the action) without needing anyone to manually facilitate the transaction.

Why Smart Contracts Matter

Smart contracts are one of the most widely used secure blockchain solutions for businesses across many different industries. And it’s easy to see why. When using smart contracts, businesses can:

• Automate transactions to reduce manual work and save time
• Eliminate intermediaries by cutting out middlemen and associated costs
• Ensure transparency by providing a tamper-proof and accessible record of all actions
• Enhance security with blockchain encryption, preventing fraud and data manipulation
• Increase efficiency by reducing administrative tasks and manual verification
• Improve compliance with automated adherence to legal and regulatory requirements

How Do Smart Contracts Work?

Smart contracts can appear complicated at first glance, but they’re not. Here’s the essence of how smart contracts work.

The Basics of Smart Contract Execution

At the very core of a smart contract is its ability to execute a predefined set of actions (process a payment, transfer ownership, etc) once certain conditions are met. To achieve this, smart contracts are written in Solidity (a programming language) before being deployed on a blockchain network such as Ethereum.

Once the contract has been deployed, it can no longer be altered. This ensures that the contract terms remain secure and transparent for all parties involved.

To give you an example, in an insurance claim, a smart contract can be coded so that it automatically releases the payout once the claim is verified. This removes the need for manual processing, reducing delays and administrative costs.

Role of Blockchain in Smart Contracts

The blockchain provides smart contracts with a secure and immutable ledger, which ensures that all transactions and contract conditions are recorded in a transparent and tamper-proof way. This prevents disputes and ensures all parties involved have access to the exact same information.

What’s more, is that the decentralised nature of blockchain also means that no single entity is in control of the contract. This enhances security and eliminates the risks that are typically associated with centralisation, such as fraud or data manipulation.

Smart Contract Code and Automation

Smart contracts rely on code (most commonly Solidity) to define their rules and execution logic. Once the smart contract is coded, it’s deployed on the blockchain network (usually Ethereum), after which it becomes active.

In terms of automation, it plays a crucial role in smart contracts as it removes the need for manual intervention. This not only reduces the risk of error and fraud but speeds up processing time.

Key Features of Smart Contracts

Smart contracts offer a range of features that make them highly effective for automating transactions and ensuring the secure execution of agreements. They include:

Decentralisation

Since smart contracts are deployed on a blockchain network such as Ethereum, they are decentralised, meaning they are not controlled by any single entity.

This reduces the risk of manipulation or interference from third parties, ensuring that the contract operates transparently and without the oversight of any central authority.

Transparency and Security

All parties involved in a smart contract can access the terms and execution logs on the blockchain. This transparency helps ensure that all participants are on the same page and that there is no ambiguity regarding the contract’s conditions.

Immutability

Once a smart contract is deployed on the blockchain, it can no longer be modified. This immutability ensures that the contract’s terms are permanent and cannot be altered, which further strengthens security and trust.

Cost and Time Efficiency

Since smart contracts are self-executing, there is no need for a middleman, which will save all parties involved some extra money. Aside from that, smart contracts are also very time-efficient since they automatically execute the terms of the agreement without any delay once the set conditions are met.

Benefits of Using Smart Contracts

There are many benefits to using these digital agreements that are powered on the blockchain, including:

Increased Trust and Reliability

Since smart contracts are automatically executed based on code, they remove the uncertainty of manual enforcement. In other words, all parties involved can trust that the contract will be executed as programmed.

Enhanced Security

Thanks to blockchain encryption, smart contracts are incredibly secure as they don’t allow for unauthorised modification, reducing the risk of fraud.

Reduced Risk of Human Error

No matter how skilled or experienced a person might be, the risk of making an error is never zero. It is, however, when using a smart contract. So, if you’d like to bring the risk of human error to zero, using a smart contract is a wise choice.

Faster Transactions

Rather than waiting for the middleman to verify if all the conditions on the contract have been met, when that happens using a smart contract, the contract will be executed immediately, saving a lot of time that would have otherwise been wasted.

Cost Savings

By cutting out the middleman and any administrative costs that are typically associated with contractual agreements, all parties involved will save money when using smart contracts over their traditional counterparts.

And while it may not make a world of difference when smart contracts are used if and when needed, when used at scale, the cost savings can be substantial.

Common Use Cases of Smart Contracts

To give you an example of how smart contracts work, let’s take a closer look at some of their applications across different industries.

Smart Contracts in Finance

Banks and other financial institutions use smart contracts to automate payments, process loans, and handle insurance claims. The use of smart contracts allows companies in the finance industry to not only become far more efficient but also reduce the risk of human error and fraud.

Smart Contracts in Supply Chain Management

Smart contracts have completely transformed the supply chain management industry. From tracking goods in real-time to automating payments and verifying compliance, smart contracts streamline operations, enhance transparency, and reduce the risk of fraud.

Smart Contracts in Real Estate

Whether it’s the transfer of a property,  rental agreement, or the processing of payments through Escrow, using smart contracts not only enhances security but speeds up the entire transaction by reducing reliance on intermediaries.

Smart Contracts in Healthcare

From insurance claims and medical records to patient data management, smart contracts can be used in the healthcare industry to verify insurance coverage, facilitate payments, and ensure compliance with data privacy regulations.

Final Thoughts

Smart contracts have completely changed the way agreements and transactions are approached. By automating processes, enhancing security, and removing the need for intermediaries, they offer a more efficient, cost-effective, and transparent alternative to traditional contracts.

Hopefully, after reading this article, you now have a better idea of what smart contracts are, how they work, and whether they can be beneficial to you and your company. If you’d like to learn more about blockchain technology, consider reading our article that explains how database and blockchain work together.