How Do Smart Contracts Work?

How Do Smart Contracts Work?

If you’re even slightly interested in the world of blockchain, you may have heard or read about the phrase “smart contract”. But apart from being the digital cousin of a drafted paper contract, how exactly do they work?

It cuts out the middle man

At the core, smart contracts are pieces of code deployed on the blockchain which execute certain instructions once a series of conditions are triggered. A simple analogy would be to think of them as vending machines which dispense funds or other assets to intended parties. In addition, certain rules and conditions can be coded in to ensure that funds are only released once these are met.

Unlike paper contracts, smart contracts don’t need to be witnessed by a lawyer or notary as nodes on the blockchain will verify the potential transaction instead. Furthermore, unlike the hassle of following up and chasing for payments in the offline world, smart contracts ensures automatic execution once this set of conditions are triggered as per the code. The public ledger allows for transparency and accountability, with outside parties able to observe the market activity, but also maintains the anonymity of the parties involved.

For example, smart contracts can assure investors in crowdfunding projects that the founders are actually making progress and using funds to accelerate development. If milestones cannot be met, the funds will be returned to investors.

Unlike paper contracts, smart contracts are executed immediately once certain requirements are met. Image from worldcoinindex.com

Benefits of smart contracts

One of the key benefits of smart contracts is automatic execution as mentioned earlier. This also ensures complete accuracy as long, confusing forms don’t need to be filled out. In addition, there is no possibility of manipulation by a third party as there are no lawyers or intermediaries involved in the process.

Smart contracts are essentially pieces of code; this means that it’s extremely fast. While the execution of a traditional contract can take anywhere from a few hours to a few years, smart contracts are fulfilled as soon as the conditions programmed in are met.

As all nodes on the blockchain will have a copy of the smart contract, this means that it’s impossible for it to go missing, unlike physical copies. Furthermore, the transparency of the blockchain means that smart contracts can be fully trusted as all transactions must be verified by the nodes.

Industry use

Smart contracts have the potential to disrupt and revolutionize the way business is conducted, and even how society functions. However, there is a long way to go before smart contracts become the norm in various industries. Currently, the Ethereum blockchain platform provides the most leeway for flexible smart contracts.

With an understanding of the basic concept of a smart contract, it’s possible to envision a future where all functions of various industries are tied to smart contracts. However, it’s important to note that smart contracts are still considered to be in the early phase and aren’t bulletproof. The most notable example is The DAO, a digital decentralized autonomous organization which intended to offer a decentralized business model for commercial and non-profit ventures.

Smart contracts could potentially change the way entire industries work! Image from actechatter.com

Due to a flaw in its open-source code, malicious users managed to siphon off a substantial amount of The DAO’s funds. Although the funds were recovered through a hard fork which led to the formation of Ethereum Classic, it just goes to show how smart contracts are still susceptible to attacks.

The immediate future will involve ironing out kinks in existing software and figuring out how to embed more complex decision-making into future smart contracts. As of now, smart contracts are helping to decentralize trust and is the basis of many initial coin offerings (ICOs) being launched by companies around the world. When this transition is complete, it could very well change the world as we see it.

The independent firm Zeppelin Solutions has audited the code that makes up the EVR token and verified that there are no security leaks.

Cover image from blockgeeks.com

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