Smart Contracts Explained
Have you ever heard of Smart Contracts or ever had an interest in them? Great, you are in the right place. Today I’m going to cover how these smart contracts work, what are the use cases, the benefits, risks, and are they really smart.
First of all to all who don’t have an idea about, “what is this Blockchain?”,
Blockchain is an immutable, shared ledger that usually use in business to record transactions and track assets. Most of the cryptocurrencies are also based on a blockchain and these smart contracts are stored on these blockchains.
How Smart Contracts works?
Smart Contract is a simple program that stores on a blockchain and runs when the predetermined conditions are met and verified. These are typically used to execute an agreement between two or more parties. The smart contracts have the capabilities of receiving, storing, and sending funds and trigger the next action when conditions are met. Nowadays, Smart Contracts are used in supply chains, government voting systems, healthcare, financial services, and much more.
All smart contracts are immutable. That means, when smart contracts are deployed, they cannot be modified again. These Smart Contracts are worked by a simple program following “if, when, then” statements that are written on the blockchain. When the transaction is complete, it automatically updates on the blockchain. That means, the transaction cannot be reversed because blockchains are cannot reverse to the previous state. Only parties involved in the transaction have been granted permission to see the transaction results.
The biggest blockchain which supports smart contracts is Ethereum. In Ethereum, Smarts Contracts are written using a Turing complete programming language called Solidity. Also, Polkadot, Hyperledger, Tezos, Stellar, Solana blockchains are support smart contracts but they all have different characteristics.
Let’s look at a simple example:
Imagine that Alice wants to give a book to Bob. And in return, Bob needs to give another book to Alice. Also, they want to exchange those books before noon. But they both can’t trust each other, therefore both of them invite Philipe as a middleman.
- So in the traditional way, Bob and Alice give their books to Philipe before noon, and then he exchanges those books among them. But what would happen if Philipe keeps those books without exchanging? or if he lost those books in the period of transition? or if he delays the exchange?
- And how it would be if Philipe acts as a Smart Contract? Then, the complete process would be a computer program. Until the conditions are met, the books exchange won’t happen. If Alice isn’t able to give the book to Philip before noon or if Bob isn’t able to give the book to Philipe before noon, the operation would cancel. And everything will turn back to the same as they were.
Smart Contracts were firstly proposed by an American computer scientist, Nick Szabo in 1994. His idea was to create self-executing contracts with the help of cryptography, digital signatures, and secure computation.
Use cases of Smart Contracts
1) Supply Chains
If we consider a large-scale computer manufacturing company, they have built on a complex web of relationships all around the world. This complex web includes, provide materials, manufacture the components, assemble the computers, deliver to the market, and this complex process is called the supply chain. Because of the complexity of the process, large manufacturing companies occur difficulties when tracking the supply chain.
Smart Contracts could manage this supply chain simpler and more transparently. The idea behind smart contracts in the supply chain is to create a source of all information in a single global ledger. Each component would have its own entry on the blockchain and it can get tracked all of the time. Authorized companies could update the components in real-time. In the end, the company can track all the components at any time and the decrease of the laborious process would automatically decrease the risks of fraud and loss.
Smart Contracts can be used in many cases in the healthcare sector such as health insurance, manage patient’s health records, telemedicine, verifying medical staff credentials, and much more. Let’s look into a few of them.
Health Insurance companies can use Smart Contracts to reduce many inefficiencies in the current system. If anyone uses smart contracts to buy their insurance, then all details of the policy will automatically be stored on the blockchain. And it could reduce the use of lengthy file insurance claim forms. Because if the insuree goes through a medical procedure that is covered by the insurance policy, the smart contract would be automatically triggered. And that means the money will automatically transfer from the insurance company’s account to the hospital’s account without having any delays.
Smart Contracts can also be used to store the Health Records of patients on a digital ledger. If a patient moves from a hospital to another, then they would be able to read patients’ records easily. Hospitals and healthcare companies use a number of databases filled with patient information. Then using Smart Contract and blockchain, everything can be stored in the same place with higher security.
3) Financial Services
Smart Contracts can use widely in Financial Services. This can be used in banking services to ensure the money flow between parties seamlessly. And also in the traditional way, the transaction settlement and clearance process of securities markets are really inefficient. But improving the security, smart contracts can reduce the settlement timeline to a few minutes.
And all Banking services require KYC, customer identity verification process. It is an essential step in all financial activities. However, in the traditional way, obtaining customer credit histories is tedious and costly. But it is a mandatory step to avoid financial fraud. Therefore, blockchain-based smart contracts can be used here to verify credit records of individuals and very their identities stored in a blockchain.
Not only these, in financial services, smart contracts can also use to reduce transaction costs, do audits, increase speed, and much more.
Benefits of Smart Contracts
- Accuracy — One of the most important benefits of the smart contract is accuracy. Because the smart contract is a computer program, there won’t be any human errors, but we can’t forget “bugs” in the program. Let’s talk about that later.
- Transparency — The terms and conditions of these smart contracts are fully visible and accessible to relevant parties. And also anyone cannot modify the contract after it executes on the blockchain. Therefore, this facilitates the transparency of all the transactions.
- Speed —Smart Contracts work without involving any documents and also it is a computer program that runs live on the internet. Therefore, transactions can be executed very quickly when using these.
- Security —Automated smart contracts use the highest level of data encryptions as modern crypto-currencies use. Rather than traditional methods that data stored in papers and hard drives, smart contracts can give much higher security. This level of protection makes them one of the most secure things on the world wide web.
- Efficiency —The nature of smart contracts makes them much efficient because of the higher accuracy and speed of this technology. Higher efficiency results in the execution of more transactions per unit of time.
- Low cost — Another one of the main benefits is, it reduces the cost by eliminating the need for a vast chain of middlemen such as lawyers, witnesses, and banks.
Risks of Smart Contracts
- Bugs — DAO Hack is an example of a smart contract bug. As a result, it lost millions of dollars worth ether. Etherium community come up with very strict security measures after the incident and now pretty much all popular smart contracts have gone through a security audit. You can find out more details about DAO Hack from here.
- Protocol Changes — We still cannot guarantee that changes in the platform level will not cost any problems. We can imagine a situation like upgrading ethereum itself may end up with certain smart contracts behaving differently.
Not only these but there are also other risks involved in things like real-world issues, regulations, and taxes. But they believe that most of these will eventually solve.
We are still in a very early stage of smart contracts. The possible use cases of smart contracts are getting discovered day by day. And most of the problems regarding smart contracts would solve eventually. Smart contracts won’t replace lawyers soon, but it has very bright future.
Thank you for reading!!