In this era of blockchain, cryptocurrencies and NFTs it’s hard to believe that you didn’t come across the term smart contracts.
The world, especially the business and financial world, is incomplete without contracts. Contracts legally bind two parties with predefined terms and conditions.
However, most of these contracts are overseen by trusted third parties. They ensure that both parties involved in the contract go to the pre-set terms. In addition, when involved parties don’t abide by the terms, they are often tangled up in lawsuits.
So how can you ensure the fairness of a deal? Is there another way to create more effective contracts?
This is where digital decentralized smart contracts come in.
With blockchain becoming mainstream in the business and financial realm, you cannot ignore smart contracts. While some of you have a little idea about it, the majority don’t.
That is why today we are here with a detailed guide on the concept of smart contracts. We will also focus on its types and applications across various industries.
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What Are Smart Contracts?
Smart contracts are digital coded protocols over a blockchain network that verifies, oversees and self-executes an agreement if parties meet the predefined rules.
Smart contracts are digital contracts built over the blockchain network. These are computer programmes that automatically execute themselves as per the pre-determined terms.
Mostly these contracts are used in the transfer of digital assets between parties. Similar to physical contracts, smart contracts execute the deal as they are written. The only difference is that smart contracts are coded and decentralized. Also, unlike physical contracts, the agreement is between anonymous parties.
You do not need a third party to oversee the execution or fulfilment of the contract. Moreover, if one of the involved parties does not follow the terms, the contract automatically rejects the transaction. Thus, there is no loss to the second party.
The best thing about smart contracts is that it eliminates human involvement. So, in a way eliminates human error through automation.
According to The Chamber for Digital Commerce, the definition of a smart contract is as follows:
“Computer code that, upon the occurrence of a specified condition or conditions, is capable of running automatically according to prespecified functions. The code can be stored and processed on a distributed ledger and would write any resulting change into the distributed ledger”
Nick Szabo, an American computer scientist, invented smart contracts. He was trying to execute the terms of the contract using computerized transaction protocols and distributed ledger.
In 1994, he theorized that digital contracts can be coded, replicated, stored and supervised by a network of computers.
Features Of Smart Contracts
Here are some of the essential features of the smart contract.
Distributed – Everyone on the network gets a copy of the conditions of the smart contract. It is distributed across all nodes of the network.
Deterministic – A smart contract will function only when the conditions are met. No one can change the terms. Also, it does not matter who is executing the contract, the final output will not change.
Immutable – being stored over a blockchain network, no one can hack or alter the smart contracts.
Decentralized – No third party or governing body is required. Smart contracts are self-executing codes which are controlled by nodes of the network.
Transparency – Being stored on the public distributed ledger the code is visible to everyone whether they are participants.
Trustless – Smart contracts are automated and do not require any trusted third party to ensure that the conditions of the contracts are met.
Self-verifying – Because of automatic options, these are self-verifying.
Self-enforcing – These are self-enforcing when the requirements and guidelines are adhered to at all times.
Benefits Of Smart Contracts
Have a look at some of the benefits of smart contracts.
Speed, efficiency & accuracy
Once the conditions are met, smart contracts execute immediately. Thus, there is no lengthy documentation or approval process.
Trust & Transparency
All data are distributed and visible to everyone on the public distributed ledger. Moreover, there is no involvement of a third party and everything is automated. So, you can trust the fairness of the deal.
Smart contract protocols are built over blockchain networks which itself is a hack-proof and immutable technology. Therefore, no one can hack or alter the data of smart contracts in any way.
As smart contracts eliminate intermediaries, the entire agreement process becomes cheaper, fast and more efficient.
How do Smart Contracts Work?
You all know how conventional contracts work. It involves lawyers, a lengthy documentation process, unnecessary fees and lots of other things. Moreover, you will have to recheck everything and ensure that the other party also agrees and abides by it.
But in the case of smart contracts, the mechanism is different.
- All the details and terms of the agreement are coded.
- You can also include deadlines or time constraints in the contract.
- It requires a sequence of events to occur to fulfil the outcome of the contract.
- A smart contract is deployed only when both parties agree to the terms.
- Every smart contract has an address on the blockchain.
- Anyone can view the smart contract using this address.
In simple words, smart contracts are executed based on the IF-THEN concept.
- If you send A, then B will be transferred to you.
- If you fail to send A, then B will not be transferred to you.
- If you finish certain work, then A will be transferred to you.
You can use the WHEN constraint to include time in your contract. Additionally, you can include as many IF-THEN constraints as you require in the contract.
- If you put your NFT as collateral, then you will get the loan amount.
- The smart contract includes the loan amount, interest rate and repayment deadline.
- If you repay the loan in time as per the contract, you will get back your NFT.
- If you fail to pay back the loan, then the NFT will be transferred to the lender.
Here the NFT lending process is executed automatically and efficiently without any human involvement through smart contracts. Smart contracts help to maintain the fairness of the deal for both the parties. The digital contract works as per the coded rules which directs it to take certain actions for specific events.
Types Of Smart Contracts
There are three types of smart contracts.
- Smart Legal Contracts
- Decentralized Autonomous Organisations (DAO)
- Application Logic Contracts
Let us now understand each of them.
Smart Legal Contracts
These contracts are legally binding that require parties to fulfil their contractual obligations. In these types of contracts, parties will face legal actions if they fail to comply.
Decentralized Autonomous Organisations (DAO)
DAO are the next revolution in running an independent and efficient organisation. It eliminates the role of central authority in the organisation.
DAO also introduces transparency, automation and security into the organisation. They are open-source and incorruptible protocols.
Smart contracts are the backbone of DAO. These contracts specify governance rules which are coded into the blockchain.
The entire DAO community functions as per the coded rules and all members have to abide by them.
Application Logic Contracts (ALC)
Application Logic Contracts are purely for devices and applications. They enable applications to function autonomously and securely.
ALC are application-based codes that facilitate interoperability across various devices. ALCs bring more transparency, automation, cheaper transactions and scalability.
Smart Contract Development Process
You can integrate smart contracts into your business ecosystem. It will help you achieve greater efficiency with enhanced security, automation, transparency and decentralization.
As a leading smart contract development company, we build custom smart contracts as per your business needs. Get in touch with us to upgrade your business and boost its growth.
For now, let us have a look at how you can create smart contracts.
Identify Business Agreements
Firstly, you will have to sit with the involved parties to set clear terms and conditions of the agreement.
If the rules are vague, it will lead to disputes and eventually, the smart contract will fail.
Outline a clear picture of the rules of the contract and output.
The next step is to specify the desired behaviour of the smart contracts in response to certain events. You can also set payment authorizations, asset swaps, repayment deadlines and legal constraints.
Please note that you cannot make smart contracts execute contradictory terms. These digital contracts function only as they are coded to do.
Code Smart Contracts
You will have to hire smart contract developers to code your terms. The developers will code your contracts, test them for bugs and deploy them on a blockchain platform.
While developing smart contracts, you should focus on their security. You should get a rigorous testing process and security review to identify any loopholes.
Once the developers encrypt and execute the smart contracts on the blockchain, every node receives a copy of it. After the blockchain network verifies the smart contract, you cannot change it.
Use Cases Of Smart Contracts
Here are some of the fascinating uses of smart contracts.
Supply Chain Management
- Streamlines the flow of goods
- Identifies and removes unnecessary steps
- Track manufacturing, shipping and handling processes
- Creates a trusted, automated and decentralized trade ecosystem
- Automates the trading process
- Eliminates fraud and human errors
- Resolves discrepancies in financial settlements
- Automates documentation, transactions settling and other processes
- Draft codified self-executing efficient smart contracts to avoid any disputes
- Smart contracts made NFT minting possible
- Stores crucial assets data like ownership history and more
- Enables proper digital asset management
- Removes lengthy documentation process
- Makes the entire process cheaper by eliminating middlemen
- Digitalize, automate and simplify property ownership agreements
- Enables fractional tokenisation and REITs
- Effectively store and transfer highly sensitive data like patient records
- Improve cross-institutional visibility of clinical trials
- Automate data sharing & ensure data privacy
- Helps to manage government schemes better
- Reduce auditing costs
- Improve transparency in the government systems
- Securely store and transfer data among institutions
- Help in conducting fair elections
- Store record of ownership of a music track on blockchain
- Resolve music copyright issues
- Help musicians earn royalties through smart contract backed music NFTs
Smart contracts are making blockchain technology more robust and scalable. It is the core concept that is encouraging institutions to adopt blockchain solutions.
Smart contract powered blockchain solutions are helping businesses streamline, automate and decentralize their operations. In a way boosting business growth and opens doors to new opportunities.
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