Smart Contracts: what they are, how they work, and their uses
After a couple of years since the cryptocurrency and blockchain boom began, it's a fact that web 3 will change the way we do many things, especially in business and finances, making them cheaper, streamlining transactions, and decentralizing finances. But, of course, this can’t be achieved without the intervention of smart contracts. These contracts, stored on the blockchain, are the breakthrough that will change how businesses are done today.
What is a smart contract?
Contrary to what everyone seems to believe, the technology of smart contracts is not new. The first time the word was used was in 1995. A year later, Nick Szabo published on his website the text “Smart Contracts: Building Blocks for Digital Markets,” where he defined the theory of the blockchain and smart contracts.
Now, What are smart contracts? Like any other contract, they are documents, in this case, digital, that specify the conditions to carry out a transaction between two or more parties. They are made entirely of code and are executed automatically. Therefore, they do not need intermediation of any kind. Unlike contracts in the real world, if one of the parties does not comply with the contract, it's not executed. Thus, avoiding the use of middlemen or entities that verify that the contract is fulfilled.
Smart contracts are stored in a blockchain and executed when predetermined conditions are met and cannot be modified. Transactions are also processed on the blockchain, which automates payments and actions.
The primary value of blockchain technology lies in reinforcing security, transparency, and trust between signatories of a contract, avoiding misunderstandings, forgeries, or alterations, dispensing with intermediaries, and keeping the outcomes fair for all parties involved.
How do smart contracts work?
The operation of smart contracts is very simple and is not very different from a contract in the real world. In this case, there is no third party to ensure that the contract is fulfilled and, in most cases, no legal entity to turn to if the contract is not.
Let's see an example of how this works. You want to rent an apartment to spend the weekend at the beach. For the contract to become effective, you must pay the rent, but you do not know the lessor, and you are afraid he could run with your money. On the other hand, he must give you the key, but he doesn’t know if you will keep the key without paying him.
The smart contract ensures that both parties receive their share without having to trust each other. For example, you will deposit your money, and the lessor will deposit the key. Once both things are deposited, the contract will be executed automatically, giving you the key and the money to the lessor.
If one of the two does not deliver their part, be it the money or the key in the stipulated time, the contract doesn't execute, and the transaction is reversed. This way, you do not need to trust or know the people you are doing business with because the contract protects you and your assets.
Smart contracts can't be edited. Once programmed and uploaded to the blockchain, the contract terms can't be changed. It would immediately alert the other parties if someone tried to do so, so it would be practically impossible to alter the contract's terms. Likewise, the transactions carried out by the smart contracts are registered within the blockchain. Therefore, they are verifiable, secure, and immutable.
Advantages of smart contracts
Transparency: Smart contracts are completely transparent to all interested parties. All the people who are part of the contract will be able to see the terms and conditions of the agreement. If any parties want to make any changes, this must be done before the contract is ready and mounted on the chain. Once there, it is no longer possible to change the terms.
No miscommunication: Smart contracts are automatic, and the terms of the agreement are detailed in their programming. Therefore, there is no possibility of misunderstandings or problems in communication. since everything is done automatically and virtually without human intervention.
Guaranteed outcomes: Smart contracts are 100% automated and always have predictable results. So, as long as the requirements are met, the response triggered will always be the same.
Safe and trustless: Smart contracts do not need trust between people or a third party, unlike today's traditional contracts. On smart contracts, one action will always trigger another as long as the conditions are met by all interested parties. The contract is executed, and everyone receives their part. If one of the parties does not fulfill its commitments, the contract is reversed, and no one puts their assets or capital at risk.
Disadvantages of smart contracts
Confidentiality: For now, one of the disadvantages of the blockchain is its confidentiality. By being registered in the chain, everyone who has a copy can see all the contracts and their terms, which may not be very good for some industries or companies.
Bugs: It is not uncommon for developers to make a mistake when writing any kind of code, but this can be a big problem in the case of smart contracts. A bug can prevent the contract from being executed correctly or entirely, resulting in unpleasant situations for the contract participants.
Rogue contracts: Within the blockchain, it is possible to find contracts with malicious code made by hackers whose intention is to steal and defraud the unwary. This kind of scam is fairly common.
Industries and uses of smart contracts.
Smart contracts have applications in all areas where traditional contracts are currently signed.
Supply chains: Internet of Things (IoT) devices can be used throughout the supply chain to record every step of a product and improve its traceability. In this way, errors, theft, and loss can be eliminated.
Records: Smart contracts make it easier to store and maintain records. For example, millions of confidential patient records need to be securely stored and updated.
Commerce: Most commercial activities depend on the approval of their financing, which is a time-consuming and resource-intensive process. Thanks to smart contracts, this time can be drastically reduced.
Ownership: Smart contracts can register real estate ownership more efficiently. Moreover, their use can extend beyond apartments, buildings, or land and register all types of assets.
Mortgages: Mortgage transactions are cheaper, faster, and more secure based on smart contracts. This allows buyers to access the property earlier and update records automatically.
In Soluntech, we design and develop customized smart contracts for multiple platforms to suit your company's needs. Likewise, we have the capacity to carry out a detailed audit of existing contracts. Contact us or schedule a pre consulting meeting if you need blockchain services.