Smart Contracts: How do they Work?


I bet you have heard about Ethereum, the second largest cryptocurrency after Bitcoin. One of the main products of the Ethereum blockchain is ‘smart contracts’. In this article, we shall explore what smart contracts are, their supposed benefits, and how they work. Enjoy the read…

What are Smart Contracts

A smart contract is a middleman-free protocol that is intended to contribute, verify, or implement the negotiation or performance of a contract. Put differently, smart contracts enable you to perform credible transactions such as exchange of money, shares, property, or anything of value in a transparent and conflict-free way, without the use of third parties. Smart contract-based transactions are trackable, automatic, irreversible, and cannot be manipulated once added to the blockchain.

To further explain smart contracts, think about the interaction you have with a merchant when using an escrow service. You make payments for a product with the hope that the merchant delivers the item he advertised. The merchant on the other end, ships his product to you on the belief that he will get paid. The escrow service in this case is the middleman, and there are some disadvantages to such a system.

First, an escrow service doesn’t run on charity. They’ll definitely charge for their services. There’s also the possibility of the escrow service vanishing with your money. Additionally, if there are any mishaps, the process of conflict resolution is often cumbersome. Think of how long you have to wait during charge backs.

Real-life Applications of Smart Contracts

The entire concept of smart contract seems rather vague, and it will be useless if there are no real-life applications. So, let’s look at some areas where they can be applied.

Elections: Rigging of elections is not a new thing, and there have been accusations of tampering with the electioneering process during the last US Presidential elections. Deploying smart contracts in this field will mean each vote will be put on the blockchain and distributed amongst nodes. By encrypting and making the data anonymous, there will be no possibility of manipulation.

Logistics: Traditional supply chains are long and involve a lot of links. They are also slow because each link requires a confirmation from the previous one. This is wasteful and counterproductive. With smart contracts, each participant can see the progress in the supply chain. Also, smart contracts ensure transparency with regards to shipment tracking, contract terms, and fraud protection.

Business Management: “Well, the person managing your payroll has been sick for days and you won’t be getting paid.” Does this sound good?

Conventional systems are often subject to human interference and lapses. With smart contract, you get paid when you are supposed to get paid.

ICOs: This is probably one of the most common applications of smart contract. I am certain you may have heard of ERC-20 tokens. For ICOs, once you transfer a certain amount into an account, the contract ensures you get XYZ token. No middle man or company can interfere with this.

There are several other possible applications of smart contracts in banking, real estate, insurance, IoT, etc.

In general, smart contract provide a stress-free way of implementing contracts. Other benefits include its autonomy, safety, speed, and accuracy.