What are Smart Contracts and how do they work?

What is a smart contract?

A smart contract is a computer protocol intended to digitally facilitate, verify or enforce the negotiation or execution of a contract between two or more parties. Smart contracts enable the execution of credible transactions without third parties. These transactions are traceable and irreversible.

They are called “smart” because the terms are specified and enforced in the form of code executed on the blockchain, not on a piece of paper kept by a notary.

How do smart contracts work?

With conventional contracts, a document outlines the terms of a relationship between two parties. If party A violates the terms, party B can take party A to court for failing to honor the agreement. A smart contract fortifies such agreements in the code so that the rules are automatically enforced without any third party getting involved.

A simple example of a smart contract is:

A vending machine can be thought of as a very simple version of a smart contract. If you put money in the machine and select your product, the machine will dispense your product without any human input or verification. The code inside the vending machine defines how it works-if you put in 1 euro, then you will get a can of Coke (or whatever you choose) from it.

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The code that makes up a smart contract is open source, meaning it is publicly available. This allows anyone to check the code for security vulnerabilities. It also allows developers to integrate existing smart contracts.

What are the benefits of using smart contracts?

A key benefit of using smart contracts is that they automate processes, which eliminates the need for human involvement in transaction execution

With smart contracts, there are no intermediaries required to verify the validity of a contract or transaction, which makes them significantly less expensive than traditional paper contracts. Smart contracts also save users time through automation, and because everything is recorded in code on the blockchain, it prevents any party from making changes.

No third party required: The agreement is only between two parties and does not require an intermediary to execute the contract. This saves time and money for both parties involved.

No trust: The contract itself is stored on an immutable ledger, so it cannot be altered or deleted by either party. This means there is no need to trust each other because everything is recorded in an open, shared database that everyone can see and verify for themselves.

Secure: In addition to being stored on an immutable ledger, smart contracts are also protected with encryption that makes them extremely difficult (if not impossible) for hackers to tamper with or alter in any way.

Transparency: Changes to public blockchains are publicly visible to all parties creating transparency.

Immutability: Once a transaction has been made it cannot be reversed or tampered with making it secure and reliable.

Speed: Transactions are processed almost instantaneously, 24/7.

What are the potential risks associated with using smart contracts?

The biggest risk with smart contracts is that they are software and, like all software, are vulnerable to bugs. But unlike most software, a bug in a smart contract can lead to the loss of millions of dollars, and there is no one to appeal to for a refund.

Are there limitations to using smart contracts?

Smart contracts have limitations, including:

Security: Smart contracts are only as secure as their code and the systems on which they run. If a smart contract is exploited, it can lead to significant financial losses.

Human error: The programmer of a smart contract has the possibility of writing faulty code. If the code contains errors or bugs, the contract may not work as intended, and changing the processes of these smart contracts is nearly impossible-any errors in the code can be costly to correct in both time and money.

Cost: It can be very expensive to create a smart contract. Some experts believe that the cost of creating and maintaining a smart contract is too high, compared to traditional contracting methods.

Third parties: Although smart contracts try to eliminate the involvement of third parties, it is not possible to eliminate them altogether. Third parties take on different roles than they do in traditional contracts. For example, lawyers will not be needed to prepare individual contracts; however, they will be needed by developers to understand the terms to create codes for smart contracts.

What are the challenges of using smart contracts?

Smart contracts can be incredibly useful in a variety of scenarios. However, the technology is not without its challenges.

Here are some of the most common problems people have with smart contracts:

Scalability – Currently, smart contracts are slow and expensive to run on public blockchains. This is because every node in the network has to validate every transaction, regardless of whether it involves them or not.

Security – While smart contracts are immutable, this does not mean they are perfect. Bugs have allowed hackers to steal millions of dollars from smart contract platforms such as Ethereum and EOS.

Reliability – Because users generally rely on third parties to create and distribute smart contracts, it is possible for them to manipulate the system for their own purposes.

How will smart contracts change the way we do business?

Blockchain is almost certainly here to stay. It is currently one of the hottest topics in business, finance and technology circles, and it has the potential to change the way we do business at a fundamental level.

Are smart contracts only on Ethereum?

Ethereum currently in 2022 is the most popular smart contract blockchain. However, many other cryptocurrency blockchains, including Tron, EOS, Tezos, Neo, Algorand and Polkadot and many others support smart contracts.

Anyone can create and distribute a smart contract on a blockchain. The code is transparent and publicly verifiable. Any participant can see exactly what logic a smart contract follows when receiving digital resources.


Hey, I'm a crypto lover and the chief editor at Cripto Exposed. I've been passionate about blockchain and cryptocurrency for years and am always looking for new ways to explore this exciting space. I'm committed to writing only the most up-to-date and meaningful stories related to crypto and blockchain-related trends. If you want to stay in the know on cryptocurrency, follow my pages! Let's continue the crypto revolution together. #StayCrypto

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