What are smart contracts?
- Smart contracts are automated, code-based applications that execute agreements when specific conditions are met.
- They operate on a blockchain, reducing the need for traditional middlemen like lawyers or brokers.
- Smart contracts run on basic "if this, then that" logic, making them highly transparent and efficient.
Smart contracts are applications written in code whose functions execute automatically when their predetermined requirements are met. The Ethereum blockchain, which exists on computers all across the world, is well known for its ability to run smart contracts. They help users exchange money, property, shares, assets, or anything else that is digitally representable. Since they are based on the blockchain, smart contracts offer a transparent way of making transactions while often cutting the costs and services associated with a middleman.
What are the main benefits of smart contracts?
Smart contracts offer many benefits that traditional contracts simply cannot replicate as easily.
| Benefit | Description |
| Autonomy | You do not necessarily have to rely on third parties, like lawyers, brokers, or notaries, to make an agreement. |
| Cost efficiency | Removing the middleman can reduce the costs of doing business and executing transactions. |
| Speed | There is no paperwork or manual processing. The network manages the execution automatically once called upon. |
| Security | Written on a shared, distributed ledger, the contracts are highly resistant to hacking and unauthorized changes. |
| Trustless execution | Automated execution based on formal logic reduces the need to place trust in third parties. |
Of course, because smart contracts are written in code, if you cannot write the code yourself, you must understand that you are placing your trust in the developers who write it for you.
How do smart contracts work?
To explain how smart contracts work, let us compare the technology to a vending machine. The conditions of a vending machine are simple: if you put $2 in, a water bottle comes out. If you do not put $2 in, a water bottle does not come out. The same principle applies to smart contracts.
Smart contracts define the rules and penalties around an agreement just as a traditional contract does. The difference is that they automatically enforce those obligations if someone activates them.
To put it in other terms, smart contracts run on formal “if this, then that” logic. If certain conditions are met, then the smart contract executes the agreement. If the conditions are not met, then the smart contract does not execute the agreement.
The blockchain network validates legitimate transactions, but a constraint within the contract code can still prevent funds from being wired if the rules are not followed exactly.
What are smart contracts used for?
Smart contracts can be used as an application to store and process all manner of information on blockchains like Ethereum.
You can store information about an application, such as membership records. You can make agreements between users, like leases, trades, or bets. Smart contracts can also store insurance policies, ownership of assets, personal information, and other records. Importantly, smart contracts can be entire computer programs stored and executed on distributed networks. The potential applications of smart contract technology are vast.
To execute smart contract code on the Ethereum network, a user needs to pay a transaction fee. The amount of computational work required for the execution is denominated in "gas," and gas is typically bought with the network's native cryptocurrency, ether (ETH).
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