What is a Smart Contract? [Beginner's Guide]

Salomon Kisters

Feb 14, 2023

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Smart Contracts are a revolutionary technology that has the potential to transform many industries by enabling secure, transparent, and trustless digital transactions.

They are self-executing contracts with the terms of the agreement written directly into code and stored on a blockchain network. This means that once a Smart Contract is deployed, its terms and conditions cannot be altered, ensuring that all parties involved fulfill their obligations.

Furthermore, Smart Contracts are automatically executed when certain predefined conditions are met. For example, in a real estate transaction, a Smart Contract could automatically transfer ownership of a property from the seller to the buyer once the agreed-upon purchase price has been received.

This eliminates the need for intermediaries, such as lawyers or real estate agents, to facilitate the transaction, reducing costs and increasing efficiency.

The decentralized nature of blockchain technology provides a secure and tamper-proof environment for Smart Contracts to run. This eliminates the risk of fraud or manipulation, as the contract’s code and terms are transparent and stored on multiple nodes on the network.

This also means that Smart Contracts can be used in a wide range of industries, including finance, supply chain management, and insurance, to name a few.

Why do we need Smart Contracts?

To understand Smart Contracts, we must first comprehend how conventional contracts work.

Two parties are involved in a traditional contract, using the services of a third party they trust to execute the Contract’s bidding. For example, you wish to order pizza from a local vendor via Uber Eats.

You place an order and pay with your card. In this case, the third-party, Uber Eats, ensures a smooth exchange of money and food between you and the restaurant. This might look simple, but this trade has many aspects.

Most notably, UberEats charges commission from restaurants on every food order they receive through its platform. This is a hefty price to pay for the food business owners.

One of the most aggravating things you as a customer have to face is when you are supposed to get a refund in case your order gets canceled. The hefty processing and prolonged waiting just for a refund are bothersome. The list of problems with traditional contracts goes on.

Smart Contracts counter many issues by omitting the need for the third party entirely. It does so by removing the dependency on third parties to execute a contract with the technology applied in Smart Contracts and automates the entire process without the need for any foreign mediation.

An easy way to visualize this is by learning how a vending machine functions. The vending device registers your input when you put money in the vending machine and press the button for whatever snack you want. It calculates your cash and what snack you want.

Once that happens, a lever causes the snack to come out for you. The vending machine eliminated the need for an intermediary or escrow service. This is what happens in a Smart Contract.

What is a Trustless Digital Transaction?

A trustless digital transaction is a type of transaction that does not require trust in a central authority or intermediaries to ensure its security and execution.

In a trustless transaction, the terms of the agreement are encoded into a program (such as a Smart Contract) that automatically executes the transaction when certain predefined conditions are met.

Because the transaction is executed automatically by the program and the terms are stored on a decentralized blockchain network, there is no need to rely on a central authority to verify or enforce the transaction.

This eliminates the risk of fraud or manipulation, as the terms and execution of the transaction are transparent and stored on multiple nodes on the network.

Trustless transactions provide a secure and efficient alternative to traditional transactions, where trust in intermediaries such as banks or lawyers is necessary.

With the rise of blockchain technology and Smart Contracts, trustless transactions are becoming increasingly popular for a wide range of use cases, from financial transactions to supply chain management.

What are the Programming Concepts behind Smart Contracts?

A lot goes into building Smart Contracts. Smart Contracts are built using programming concepts such as:

Boolean logic

This is the foundation of Smart Contracts and is used to define the conditions under which the contract will be executed.

For example, a Smart Contract for a real estate transaction could use boolean logic to automatically transfer ownership of a property from the seller to the buyer once the agreed-upon purchase price has been received.

State transitions

Smart Contracts have a state, which changes as the contract is executed. The state transition is the process of updating the contract’s state as conditions are met and the contract is executed.

Public key cryptography

This is used to securely store and transfer data on a blockchain network. In Smart Contracts, public key cryptography is used to verify the identity of the parties involved in the transaction and to ensure that only authorized parties can access the contract’s data.

Solidity

This is a high-level programming language used to write Smart Contracts on the Ethereum blockchain. Solidity was specifically designed to allow developers to write secure and complex Smart Contracts.

Blockchain technology

Smart Contracts are built on top of a blockchain network, which provides a secure and tamper-proof environment for the contract to run. The decentralized nature of blockchain technology ensures that the contract’s terms and execution are transparent and stored on multiple nodes on the network.

These programming concepts are used together to create Smart Contracts that are secure, transparent, and efficient. With their potential to disrupt many industries, Smart Contracts have become an increasingly popular tool for executing digital transactions in a trustless manner.

How does Smart Contract work?

The basic principle behind using Smart Contracts is “if/then”. It works upon the idea that IF a condition in the Contract is met, THEN it will cause a set of predefined actions to be executed. Therefore, they are programmed codes meant to carry out a function upon meeting specific criteria.

The terms and conditions of the agreement are composed in the form of regulation. The action is carried out in the blockchain’s decentralized platform allowing for more assurance by authorizing transactions. These agreements foster the exchange of money, shares, property, and much more.

The history of Smart Contracts

Nick Szabo, a computer scientist, law scholar, and cryptographer, coined the term Smart Contract in 1994.

His idea was to create a universal ledger to keep track of contracts. This was made possible with the rise of Ethereum some years ago. He created this term to use a distributed ledger to store contracts. These contracts came to life with the emergence of Ethereum several years back.

Ethereum is the Primarily Associated Platform

The first platform to ever implement Smart Contracts was Ethereum, and it has worked the most in technology development.

Ethereum accounts are what most Smart Contracts are based on. The blockchain platform allows users to obtain a balance and utilize it in transactions. Instead of a user, its network controls the application of Smart Contracts, and once the Contract has been deployed, it becomes immutable, immune to any change.

Concerned parties can then make transactions triggering the implementation of the subtext of the Contract. Any activity related to the Contract by the involved parties is irreversible and permanently recorded in the network.

Solidity – The language of Smart Contract

There are two languages that Smart Contracts are written in, like Vyper and Serpent, but the most widely used in blockchain implementation is Solidity. It has all the critical features of mature programming languages, including the option of adding loops.

Therefore anyone who can learn this language can compose a Smart Contract and implement it on the network.

Uses and Implementation

This new technology can eliminate voting malpractices by ensuring no errors or incursions affect the result that the standard centralized voting system works upon.

The terms and conditions of voting are already set in the Contract, and no voter can vote using the digital key of any other person; thus making the whole process crystal clear.

Another mainstream example is the flight insurance scheme. Imagine your flight is late, but you have already spent money on the ticket. From 2017 - 2019, AXA provided insurance on flight delays using Ethereum’s Smart Contracts.

The Contract had been programmed to refund the passenger if their flight was later than 2 hours.

The database for all the flight timings was already available on the Ethereum network. Thus, it functioned to self-execute when something like this happened and saved tons of processing just for a refund.

Advantages of Smart Contracts

With the rapid rise in the use of Smart Contracts, major industries have adopted this technology in their system, with insurance companies and mortgage contractors being the leading examples. The success of this technology will only rise.

It is clear that Smart Contracts are better than conventional ones and are here to replace them.

Independent of Third Party

There is no dependence on a third party like a bank, government, or lawyer like in a conventional contract. Thus there is more freedom in the exchange, with no unnecessary foreign regulation or interruption.

Saves Time

The contract implementation is carried out at a much faster pace when in contrast to traditional contracts. While Smart Contracts require a few minutes, the latter can extend from hours to days.

Thus Smart Contract allows you to save up on a lot of time and get the job done swiftly because it runs on a computer, fully automated with a defined set of conditions.

Swift & Transparent

Payment from the donor to the beneficiary in a Smart Contract occurs almost instantly once the conditions in the Contract are met.

This allows for a very speedy credit transfer from one party to another; unlike in conventional contracts, remittance is a manual process that requires approvals and paperwork, making things very sluggish. This is one of the reasons most people are moving towards Smart Contracts.

While transparency is quite limited in traditional contracts, Smart Contracts are 100% available. They can be accessed online by anyone at any time of the day. So anyone can inspect, audit, and validate the transactions executed by the Smart Contract.

Integrative Logging

Smart Contract is ahead in bounds and leaps when keeping a record of the transactions involved. While the standard method requires handling a lot of paperwork, files, and receipts, in Smart Contract, everything is logged automatically. It is available to backtrace from its provenance till the current date.

Cheap and Secure

The most significant advantage of using a Smart Contract is the added security that comes along with it. At the same time, traditional contracts lack adequate security measures and are often targeted for breaches and infringement.

Due to the lack of intermediaries, Smart Contracts are much more cost-effective than standard contracts, where parties have to pay a hefty sum of money to a third party.

It’s As Trustable As It Can Get

No matter how trustworthy the intermediaries in the standard contracts are, there is still a slight risk of failure or scams. The intermediaries are living humans, and humans are unpredictable.

Smart Contracts’ unique dependency on an immutable program that functions hundred percent in the way it is designed has moved many people to start using its service.

Smart Contracts in the Legal Domain

Smart Contracts have the potential to significantly impact the legal domain, but they are unlikely to completely replace traditional systems in the near future. While Smart Contracts can automate certain aspects of legal agreements, they still have limitations that prevent them from fully replacing traditional legal systems.

For example, Smart Contracts can only execute the terms that have been coded into the contract. They cannot interpret or enforce laws or regulations, nor can they handle complex legal disputes. This means that traditional legal systems are still necessary for resolving disputes and interpreting the law.

Additionally, Smart Contracts are currently limited to executing simple, predefined actions. They cannot handle the nuances and subtleties of real-world legal agreements, which often require human judgment and interpretation.

That being said, Smart Contracts have the potential to greatly improve the efficiency and speed of certain legal processes, such as property transfers and supply chain management. They can also help to reduce costs and increase transparency by eliminating intermediaries and automating certain processes.

Smart Contracts can be used to build applications by serving as a set of rules and conditions that govern the behavior of the application. The rules and conditions are encoded into the Smart Contract and automatically executed when certain predefined conditions are met.

Steps to building a Smart Contract based Application

Here are the steps for using a Smart Contract to build an application:

1. Define the rules and conditions

The first step is to define the rules and conditions that will govern the behavior of the application. This includes defining the inputs and outputs, as well as the actions that will be taken based on certain conditions.

For example, in a real estate application, the rules might include the transfer of ownership of a property from the seller to the buyer once the agreed-upon purchase price has been received.

2. Write the Smart Contract

Once the rules and conditions have been defined, the next step is to write the Smart Contract using a programming language such as Solidity. The Smart Contract should be written in a way that accurately reflects the rules and conditions defined in step 1.

3. Deploy the Smart Contract

After the Smart Contract has been written, it needs to be deployed to a blockchain network, such as Ethereum. This involves uploading the code to the network and creating an instance of the contract on the blockchain.

4. Integrate the Smart Contract with the application

The next step is to integrate the Smart Contract with the application. This can be done by building a user interface that interacts with the Smart Contract and allows users to interact with the application.

For example, in a real estate application, the user interface might allow the buyer and seller to negotiate the terms of the transaction and trigger the transfer of ownership once the agreed-upon conditions have been met.

5. Monitor the execution of the Smart Contract

The final step is to monitor the execution of the Smart Contract and ensure that it is functioning as intended. This involves monitoring the inputs and outputs, as well as the state transitions, to ensure that the Smart Contract is executing the rules and conditions defined in step 1.

The Future of Smart Contracts

With the rapid rise in the use of Smart Contracts, major industries have adopted this technology in their system, with insurance companies and mortgage contractors being the leading examples.

The success of this technology is almost certain and exciting times lie ahead.

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