What is a smart contract?
Crypto, blockchains, and now smart contracts? It's a complicated story for many people. So, in this article, we'll zoom in on what smart contracts are, what you can do with them, and why they go hand in hand with cryptocurrencies.
What is a smart contract?
Simply put, a smart contract is a digital contract between two users. Like a traditional contract, a smart contract offers all parties involved a guarantee that all criteria set in the contract will be met.
These contracts are an important part of crypto trading. They are an underlying technology that guarantees that a trade (on decentralized exchanges) is done fairly, and that both parties can trust that each condition will be carried out. They are self-executing, meaning it happens automatically, and so you don't have to make them, or even think about them in everyday life.
Traditional contracts are usually full of legal jargon and complicated terms, because of this it is often necessary to hire a lawyer so that everything is fair. Smart contracts, on the other hand, almost eliminate the need for an intermediary. Smart contracts are completely digital agreements and are fully supported by blockchain technology. That means that the same security measures designed to protect your investments are also used to ensure that your contract is honored.
Imagine a day of online shopping. Once you've placed your order, you often put your trust in the hands of the third-party courier to deliver your goods in the condition you expect. If they fail in this, there is little to no guarantee that you will get your money back for the goods you purchased. This last part is eliminated through smart contracts. An automated process ensures that if value X is achieved, value Y is executed. No third party can influence this anymore.
Why are smart contracts fraud-proof?
Because smart contracts are recorded on the blockchain, they are distributed and fraud-proof in the same way that your investments would be. So, if at some point one of the goals is not fulfilled according to your contract, your investment is refunded with almost immediate effect.
Think of a trip to your local grocery store. To get your grocery cart, you may need to put a coin in it. This mechanism holds your coin until the cart is returned. This is how smart contracts work too. They hold your investment until all obligations of the contract are met.
Because smart contracts are on the blockchain network, all users can see and verify the transaction. In fact, most blockchains are open source, meaning that anyone can check and copy the terms and operation. This provides an extra layer of transparency and security. There are a number of different blockchains in use and some of the strongest options for smart contracts are Ethereum, Solana, Polkadot, Avalanche, Fantom (and many others). Simply put, crypto smart contracts provide a reliable guarantee that obligations will be met for the benefit of both parties.
How do smart contracts work?
Simply put, a smart contract is an "If this, then that" computer program. If Person A pays X amount of money to Person B, then item Y becomes Person B's. And both parties will have certain obligations that must be fulfilled in order for those conditions to be met. But the real value of smart contracts is that they are encrypted and encoded in the smart contracts blockchain. Which makes them almost impossible to change. They are completely irreversible. And so, the terms of this contract need to be specified as logically as possible to avoid potential mishaps. Often normal contracts can be so packed with technical jargon and overlapping terms that they are a bit difficult to understand and so we seek help from a 3rd party, such as a lawyer. That expertise comes with additional costs and unconditional trust that he or she has your best interests at heart.
Smart contracts negate the need for a third person or party and offer a clearly structured sequence of terms. And on top of that, the blockchain's transparency provides even more peace of mind. Remember, the blockchain is a distributed ledger, meaning anyone on the network can view and validate the fulfillment of that contract.
What is the purpose of a smart contract?
Fundamentally, the purpose of a smart contract is to provide both parties with a means of exchange that is transparent and impenetrable. It provides assurance that both parties are protected from threats that would have previously been placed in the hands of third parties. Unlike potentially shady lawyers who jack up their rates or indifferent couriers who mistreat your valuables for a day's pay, the power and control now lie with the contracting parties.
So what are the benefits and limitations of smart contracts?
The advantages of smart contracts can be described very briefly. They offer transparency to all users, they work completely autonomously, quickly and without an intermediary. As much as smart contracts try to eliminate third parties, the best they can do is reduce the need for them. However, there will be a need for lawyers to take on a slightly different role, mostly as advisors.
But if done well, it can eliminate one of the other potential drawbacks, vague terminology. Because smart contracts are digital agreements that trade in the binary, vague contractual terms can be difficult to code, often creating gray areas beyond the language of ones and zeros. Due to the secure nature of the blockchain, these terms cannot be changed or altered. Smart contracts soften the formality of contractual procedures, give users independence and a chance to save on the costs of traditional approaches.
The details of the contract are distributed and backed up on the blockchain, meaning none of the data can be lost.
Hopefully you now understand the basics of smart contracts a bit. If all went well, you've read that smart contracts take the mediator out of the equation for the most part. Smart contracts are programmable contracts that ensure that all input requirements are executed. Because smart contracts are open source, anyone can view them, and pick out any fraudsters. Well-known blochains such as those of Ethereum, Avalanche, Fantom and Polkadot use smart contracts.