What Are Smart Contracts? Detailed Guide

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Everything you need to know about these sets of coded agreements.

Smart Contracts are a set of codes through which a service is conducted in a specific blockchain. In other words, Smart Contracts are coded agreements between two parties regarding a transaction or service. The purpose of Smart Contracts is to eliminate the need for a central authority that regulates these services. 


Day by day, the relevance of Smart Contracts is increasing as the world becomes more reliant to the world of cryptocurrency

What are Smart Contracts?

They were coined as ‘smart’ because they self-execute and regulate every service in a blockchain. Smart Contracts work as conductors, but any service done through Smart Contracts is irreversible. 

As rule definers, Smart Contracts are not controlled by single users, but rather run themselves in the network. Users then can use these Smart Contracts to run, launch, or interact with other Smart Contracts or other services.

How Were Smart Contracts Created?

Smart Contracts were initially proposed in 1994 by the American programmer Nick Szabo, the inventor of Bitgold and a potential suspect behind the identity of the pseudonym for the Bitcoin founder, Satoshi Nakamoto.

Nick Szabo wanted to integrate these sets of digital codes in a decentralized manner, where these codes of the agreement would run everything, as well as keep the identity of the two parties involved in the transaction anonymous.

Even though Bitcoin (BTC), the world’s leading cryptocurrency, was the first decentralized system to be successfully implemented in the crypto market, Ethereum (ETH) was the first to actually use Smart Contracts to their fullest utilization. Furthermore, Smart Contracts in Ethereum are not used just for transactions. They are used for regulating other services provided in the Ethereum network, such as running and launching decentralized applications (dApps), decentralized finance (DeFi), etc.

How Do Smart Contracts Work?

Nick Szabo used the metaphor of a vending machine to explain how Smart Contracts work. He suggested that in the same way that you insert money in a vending machine, and then the machine gives you the desired product, the same applies to a blockchain. This process in the blockchain would run through these agreements (with you accepting to insert the coin and the vending machine accepting to give you the product), known as Smart Contracts.


smart contacts part 1 explained

How vending machines are programmed to work. Source: Ethereum.org

smart contacts part 2

How vending machines would be programmed to work through Smart Contracts. Source: Ethereum.org

So in the same way that you insert money in a vending machine to buy a snack, you use Smart Contracts to complete transactions in a blockchain.

Smart Contracts are written in a programming language. The most notable programming languages to formulate Smart Contracts are Solidity and Vyper.

However, in order to deploy Smart Contracts, you need gas, which are fees that enable you to run services in a specific network (i.e. Ethereum), the same way you need gas to drive a car.

In terms of composability, Smart Contracts can be used as APIs, which means that several Smart Contracts can co-work to deploy a new Smart Contract.

Practical Importance of Smart Contracts

Today, a lot of blockchain platforms run through smart contracts. Some of these platforms are Bitcoin (only simple Smart Contracts), Ethereum, Cardano, Tezos, and a lot of other cryptocurrencies. 

In terms of practical usage, Smart Contracts could come in handy in voting systems (secured, easy, and quick), healthcare systems (efficient compilation of data, as well as quick access to prescribed drugs), financial services, copyright protection, real estate, mortgage, employment arrangements, etc.

Benefits of Smart Contracts

Smart Contracts were invented to ease the services of a network. Here are some of the most important advantages that Smart Contracts offer that traditional contracts do not:

  • Autonomy
    • Since services through Smart Contracts eliminate the need for a third party, the two parties are free from potential manipulations that could be done by legal contracts in centralized systems, such as banks or the Government. Moreover, as a result of this, people save themselves from unnecessary fees that third-parties (notaries, banks, etc) would require.
  • Back-up
    • Your data is safe from being lost or stolen due to Smart Contracts and the fact that data on the blockchain is duplicated.
  • Safety
    • Everything is encrypted in Smart Contracts, and Blockchain is technically invulnerable from hackers.
  • Accuracy 
    • In manual traditional contracts, the possibility of a misspelled letter or incorrect number is high, while through Smart Contracts, everything is done automatically and accurately.

Visual representation of how Smart Contracts work. Source: blockgeeks.com

Flaws of Smart Contracts

Like every good invention, Smart Contracts have flaws that limit their full potential. Some of the disadvantages of Smart Contracts are:

  • Potential errors
    • A Smart Contract could contain errors in its code that could lead to undesired outcomes or malfunctioning service. Furthermore, if a Smart Contract is poorly written, it is vulnerable to hackers, which would risk other people as a result
  • Difficult to alter
    • If minor errors are found in your deployed Smart Contracts, it is difficult, time-consuming, and maybe expensive to change and redeploy them.
  • Rely on external information
    • Smart Contracts are designed to rely on information only from outside sources, meaning that they cannot track information on what is going on with the world themselves.

Future of Smart Contracts

The future looks bright for the usage of Smart Contracts, as the world is becoming more aware of the various advantages that decentralized systems offer. More platforms and technologies might start using Smart Contracts to regulate their respective networks. 

What everyone hopes and expects for the future of Smart Contracts is that the minor flaws that people encounter when using them to be eliminated. 

Key Points

  • Smart Contracts are coded agreements between two parties regarding a transaction or service.
  • The purpose of Smart Contracts is to eliminate the need for a central authority to regulate these services.
  • The idea of Smart Contracts came from Nick Szabo in 1994.
  • Ethereum is the first cryptocurrency to utilize complex Smart Contracts.
  • Smart Contracts work in a blockchain as an agreement of two parties when a transaction or service is conducted.
  • Smart Contracts are written in programming languages such as Solidity or Vyper.
  • Smart Contracts are now used by many blockchain technologies, such as Bitcoin (simple Smart Contracts), Ethereum, Cardano, etc.
  • Besides transactions, Smart Contracts can also be used for voting systems, healthcare databases, and other financial services.
  • Some benefits of Smart Contracts are autonomy, back-up, safety, and accuracy.
  • Some setbacks that you can encounter with Smart Contracts are potential coding errors, difficulties to change them, and their reliance on external information.
  • Smart Contracts can become more useful in the future as their flaws are removed.


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