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What are smart contracts?

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27th Nov, 2022
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What are smart contracts?

What are smart contracts?

Smart contracts are self-executing contracts written in code, stored on a blockchain, that can automate various processes and transactions, eliminating the need for third-party intermediaries. Smart contracts are used for multiple applications, such as financial transactions, supply chain management, and voting systems.

Smart contracts’ main benefits are that they can help reduce counterparty risk, as the contract terms are enforced by code rather than by a third party. A smart contract’s assistance means there is no need to trust the other party to uphold their end of the bargain. Smart contracts can also help to speed up transactions and reduce costs, as there is no need to use third-party services.

Another benefit of smart contracts is that they are transparent and tamper-proof, which means that all parties can view the contract terms and precisely see the contract execution. Such transparent behavior can help to build trust between parties and negate the risk of fraud or miscommunication.

Smart contracts have the potential to revolutionize a wide range of industries. They can streamline transactions and reduce costs while also increasing transparency and trust.

A brief history of smart contracts

A smart contract can be perceived as a computer protocol intending to digitally facilitate a contract’s performance with all its intricacies. Smart contracts allow the execution of credible transactions without third parties while making them trackable and irreversible. Smart contracts provide superior security compared to traditional contract law and lower costs associated with contracting.

Nick Szabo initially proposed smart contracts in 1996 by applying the concept to various legal agreements, including financial contracts, debt enforcement, and contract arbitration. Later, Ethereum founder Vitalik Buterin built upon Szabo’s work to create a more general decentralized virtual machine that could run any smart contract.

Smart contracts are seen as a way to enforce a contract’s performance, removing the need for third-party enforcement. In this way, they have the potential to reduce transaction costs associated with contracting. They can make complex financial derivatives and other kinds of financial instruments more secure and less expensive. However, smart contracts have also been criticized for their lack of security and vulnerability to hacking.

At its simplest, a smart contract is a set of rules written in code that a computer executes when certain conditions are met. When those conditions are met, the computer automatically runs the terms of the contract.

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Advantages of Smart Contracts

Smart contracts can be used for many applications, including financial agreements, voting systems, copyright protection, etc.

One potential use case is for insurance contracts. For example, a smart contract could automatically pay out an insurance claim when certain conditions are met, such as the policyholder filing a claim and providing documentation.

Another potential use case is for supply chain management, where organizations can use smart contracts to track the movement of goods through a supply chain and ensure that all parties adhere to the terms of the contract.

Challenges With Smart Contracts

One challenge with smart contracts is they often rely on external data sources to function correctly. For example, a smart contract that tracks the price of a commodity to automatically execute a trade when the price reaches a certain threshold would need to be connected to a data feed that provides the item’s current price. The contract may not function as intended if that data feed is inaccurate or unavailable.

Smart contracts are often complex and may be difficult for people to understand, making it tough to know whether or not a contract will behave as intended.

Despite these challenges, smart contracts can potentially change how many businesses operate. They could reduce costs and increase efficiency by automating processes that are currently manual and error-prone. In addition, smart contracts could help to improve transparency and accountability by providing a record of all transactions that can be easily accessed and audited.

Working on smart contracts

When it comes to working, smart contracts act as self-executing contracts where the agreement terms between the seller and buyer are incorporated into a written code. This code is deployed onto the blockchain, which lives in an immutable and transparent state. Every time the smart contract conditions are met, its code executes accordingly.

For example, let’s say you’re a freelance writer and you’ve agreed to write ten articles for a client in exchange for $100. You could draw up a contract that states that once you deliver the ten articles, the $100 will be released to you automatically. This contract lives on the blockchain, so both you and the client can be sure that the terms will be met.

If the client tries to back out of the deal, or if you don’t deliver the articles, the contract won’t be executed, and no money will change hands. This takes a lot of the risk and uncertainty out of agreements, which is why smart contracts are so helpful.

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Current use cases of smart contracts

There are a variety of different organizations and individuals that are using or experimenting with smart contracts. Some notable examples include:

  • The Ethereum Foundation is perhaps the most well-known organization working on smart contracts. They are responsible for developing the Ethereum platform to create and execute smart contracts.
  • The United Nations has been exploring the use of smart contracts for handling humanitarian aid payments. The goal is to make payments quickly and efficiently without requiring lengthy bureaucratic processes.
  • Several central banks, including J.P. Morgan and HSBC, are testing out blockchain technology (of which smart contracts are a part) for use in financial transactions. This could potentially reduce the costs and time associated with these transactions.
  • Several startups and small companies also work on smart contract applications. Some examples include slock. It is working on a platform for sharing economy applications and Provenance, which uses smart contracts to track the origins of products and ensure ethical sourcing.

In conclusion

Smart contracts have proven extremely useful in several industries, and the shipping industry is no exception. A smart contract can automate the entire shipping process, from booking cargo space to tracking the shipment and paying for services. It can save a lot of time and money and make the process much simpler and more efficient.

Today many tech aspirants show increasing interest in wanting to understand the finer details of how smart contracts and blockchain. Now is the right time to acquaint yourself with this technology, as it will only become more prevalent in the future. 

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Pavan Vadapalli

Blog Author
Director of Engineering @ upGrad. Motivated to leverage technology to solve problems. Seasoned leader for startups and fast moving orgs. Working on solving problems of scale and long term technology strategy.
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Frequently Asked Questions (FAQs)

1How were smart contracts founded?

Nick Szabo applied the concept to various legal agreements, including financial contracts, debt enforcement, and contract arbitration. Later, Ethereum founder Vitalik Buterin built upon Szabo's work to create a more general decentralized virtual machine that could run any smart contract.

2What are smart contracts typically used for?

Smart contracts are generally leveraged to automate agreement execution so that participants are ensured of the outcome without involving any intermediary or taking excessive time.

3What are some benefits of using smart contracts?

Smart contracts present a digital alternative to paper-based agreements, which results in many tangible benefits like reducing transaction costs, ensuring higher security, and enhancing process efficiency.

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