You may have recently heard about smart contracts from a friend or colleague, and are curious to know more about this new technology. In this guide, we will explore what a smart contract is and how it works. It is one of the "building blocks" that enables the functioning of the blockchain and guarantees its well-known security standards. While this may sound abstract, know that as you read this, many companies, governments, and international organizations are working on this topic. Many are envisioning a future where nearly every aspect of our daily lives will be regulated by smart contracts, from lending artworks to rental contracts, to insurance policies.
When reading an article or watching a debate about the blockchain, it may feel like you're hearing a foreign language. And you're not entirely wrong! Despite being at the early stages of the blockchain era, a dedicated vocabulary - mostly composed of English terms - has already developed, making it difficult to understand the basic concepts of this world. Each technical term is closely related to the others, so until you have a clear understanding of the basic terms, you will continue to feel confused.
Only time will tell if this tool will become part of our daily lives. In the meantime, I will explain to you in simple terms what a smart contract is and how it works, by giving concrete examples of existing smart contracts, and illustrating some fields of application.
Table of Contents
What is a Smart Contract
How it Works
Examples of Smart Contracts
Fields of Application
Limitations and Doubts
The term "smart contract" literally means "intelligent contract." It is a type of contract that exists solely within the blockchain, such as Ethereum. Its main purpose is to be as automated as possible. Its writing involves that when certain conditions are met, the smart contract automatically triggers actions agreed upon by the parties. There cannot be any discrepancies. For example, it is not possible to try to remove clauses from a smart contract later on.
Technically, they are self-executing contracts that cannot be modified and are written in computer code. To simplify, we can say that smart contracts are the digital version of traditional contracts. However, they have a variety of functions stored on specific addresses of the blockchain that allow them to...
...perform actions automatically, without the need for intermediaries. This allows for faster, cheaper, and more secure transactions.
A smart contract is essentially a set of rules and conditions that are encoded into the blockchain. These rules dictate how the contract will function and what actions will be taken under certain circumstances. Once the contract is deployed onto the blockchain, it cannot be altered or deleted.
When a party wants to interact with the contract, they will send a transaction to the smart contract's address on the blockchain. The contract's code will then execute, performing the necessary actions and updating the contract's state. These actions can range from transferring funds, to updating a digital asset's ownership, to releasing a product or service.
One of the most well-known examples of a smart contract is the ERC-20 standard on the Ethereum blockchain. This standard is used for creating digital tokens, and it dictates the rules and functions that these tokens must have. Another example is the use of smart contracts in supply chain management, where they can be used to track the movement of goods, from the manufacturer to the consumer, in a transparent and tamper-proof way.
Smart contracts have the potential to revolutionize a wide range of industries, from finance and insurance to real estate and healthcare. They can be used for anything that requires a contract to be executed automatically, such as the execution of financial derivatives, the management of digital identities, and the regulation of voting systems.
While smart contracts have many benefits, there are also limitations and potential drawbacks to consider. One limitation is that they are only as secure as the code they are written in, and any errors or vulnerabilities in the code can lead to serious problems. Additionally, smart contracts are still a relatively new technology and there are concerns about their scalability and regulatory compliance.
In conclusion, smart contracts are a promising new technology that can bring many benefits to various industries. However, it is important to understand their limitations and potential issues, and to approach their implementation with caution. As the field of blockchain and smart contracts continues to evolve, it will be interesting to see how they will be used in the future.