What Are Smart Contracts And How Does They Work?

What Are Smart Contracts And How Does They Work? Smart contracts are at the heart of blockchain technologies. They ensure a decentralized execution of “contracts” and should ensure consistency in the network. Read Smart contracts tutorial from Coding compiler.

What is a Smart Contract?

A traditional contract away from blockchain technologies is an agreement that is made between multiple people. As a rule, the contract ensures that both parties can insist on their claims and can present the contract as proof in case of dispute in order to justify certain claims and rights. A classic contract is the lease, which in simple terms consists of two elements:

  1. The tenant transfers the rent to the landlord
  2. The landlord leaves the tenant the apartment

Often contracts therefore consist of sequences in “if-then” form. When the tenant pays his rent (for the first time), he receives the key to the apartment. This process can be simplified by smart contracts because the sequence can be automated. 

A smart contract is nothing more than a series of activities that are executed when a particular event occurs. That can range from leases to complex financial transactions. 

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What’s the difference between smart contracts and traditional contracts?

1. Third parties are eliminated
It is crucial that in smart contracts, as a rule, third parties are no longer required. To conclude a smart contract, no notary is necessary, as would be the case, for example, with land transfers with conventional contracts. Instead, the smart contract is executed by the nodes in the network.

2. Activities are carried out automatically
The if-then structures ensure that as soon as the event occurs, the subsequent activity is executed. If person A and person B close a smart contract and A fulfills his condition, then the network automatically performs the necessary action that follows. It is not necessary for B to become active at this time or to inform a third party. Instead, the nodes can check the status themselves at any time.

3. All participants are informed about status changes
The decentralized structure requires that the individual nodes process consistent information. This means that all nodes will know about status changes when an event occurs.

How is a Smart Contract Executed?

There are different types of smart contracts. The most popular platform is Ethereum. There, smart contracts are treated like an account acting autonomously. So there are no individual individuals who have access to this account. 

Instead, the actions to be performed are performed on the network. Simplified, this account can be thought of as a set of statements (program code) being executed. These include performing calculations, storing information, and sending transactions to other accounts.

Although smart contracts are written by people and stored on the blockchain, after that, execution is the sole responsibility of the network and the user is no longer able to make changes. This means that errors can still occur due to incorrect programming.

How Reliable Are Smart Contracts?

It is important to differentiate the virtual execution of the contract and its significance in the real world. Finally, only the actions to be performed are stored on the blockchain. That does not mean that they are valid in the real world. Technically speaking, it can be executed correctly, but it can not automatically serve as proof in court to prove a certain claim.

“Code is Law”

Another aspect that should be considered in smart contracts is the relevance of the program code. Only the program code of the contract is decisive for the execution. The DAO – a kind of decentralized investment platform – had then, for example, collected investor funds via a smart contract. 

There was a bug in the code that a hacker could exploit in his favor to steal the ethers. Even if it was known who was hiding behind the attack, you would have no chance to reverse the attack except for a hard-fork (in which case a reset to an earlier point in time). 

Because the hacker has only executed the code stored on the blockchain. In the real world, on the other hand, legal action could have been taken to hold the hacker accountable.

Smart Contract Applications have many uses, including the following:

  1. Government – Elections could be simplified by means of voting systems via the blockchain. The votes stored on the blockchain would have to be decoded first, for which large computing capacities would be necessary to make manipulations.
  2. Supply chain – Supply chains, which are based on many consecutive agreements, can be automated through smart contracts.
  3. Real-Estate – By eliminating intermediaries in rent payments, the process can be carried out more cost-effectively. In addition, land can be sold in smaller proportions.
  4. Healthcare – Health data can be stored on the blockchain – in cases of insurance the data can be easily referenced.

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