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How Do Smart Contracts Work?

Adam Lienhard
How Do Smart Contracts Work?

Smart contracts are revolutionizing the way we execute agreements, offering automation, transparency, and security. In this article, we delve into the mechanics of smart contracts, exploring how they operate within blockchain networks to streamline processes and enforce agreements seamlessly.

What are smart contracts?

A smart contract is a self-executing program that automates actions specified in an agreement or contract. Once completed, the transactions carried out by smart contract technology are trackable and irreversible.

These contracts enable trusted transactions and agreements to occur among disparate, anonymous parties without relying on a central authority or external enforcement mechanism.

History and origins of smart contracts

The development of smart contracts spanned several decades. Let’s explore the key events that assisted in the creation of self-executing contracts.

  1. Early concepts

The concept of smart contract technology was first proposed by computer scientist and cryptographer Nick Szabo in 1994. Szabo envisioned self-executing contracts with the terms of the agreement directly embedded in code. 

  1. Bitcoin and blockchain

While Szabo laid the conceptual groundwork, it wasn’t until the emergence of Bitcoin and blockchain technology that smart contracts became feasible. Bitcoin, introduced by the pseudonymous Satoshi Nakamoto in 2008, demonstrated how cryptographic techniques and decentralized networks could enable secure peer-to-peer transactions without the need for intermediaries.

  1. Ethereum and Turing completeness

Ethereum, proposed by Vitalik Buterin in late 2013 and launched in 2015, marked a significant advancement in blockchain technology. Unlike Bitcoin, Ethereum introduced a programmable blockchain, enabling developers to deploy smart contract technology. Ethereum’s scripting language, Solidity, allows for Turing-complete computations, meaning that any computation that can be performed by a Turing machine can be replicated on the Ethereum network.

  1. Rise of decentralized applications (DApps)

Smart contracts empowered the creation of decentralized applications (DApps), which are applications that run on a blockchain network instead of a centralized server. DApps leverage smart contract technology to automate processes and execute code in a trustless manner, opening up possibilities across various industries, including finance, supply chain, gaming, and more.

How do smart contracts operate?

Smart contracts operate on blockchain platforms, such as Ethereum, and are essentially self-executing contracts with the terms of the agreement directly written into code. The life of a smart contract consists of the following stages:

  • Creation. Smart contracts are created by developers using specific programming languages designed for smart contract development, such as Solidity for Ethereum. These contracts are written to define the terms and conditions of an agreement between parties.
  • Deployment. Once the smart contract code is written, it is deployed onto the blockchain network. This deployment typically involves paying a fee known as gas in the case of Ethereum, which covers the computational resources required to execute the contract. When a smart contract is deployed, it becomes immutable, meaning it cannot be altered or tampered with. This ensures the integrity and trustworthiness of the contract’s execution, as the terms cannot be changed arbitrarily by any party.
  • Execution After deployment, the smart contract sits on the blockchain and waits for triggering events. These events can be predefined conditions, such as a specific date being reached, a certain action being performed, or a transaction occurring. When the conditions are met, the smart contract automatically executes the coded instructions.

Smart contract technology provides transparency as all transactions and state changes are recorded on the blockchain, and visible to all participants. Additionally, the code of the smart contract is publicly available on the blockchain, allowing anyone to verify its functionality and ensure its security.

Applications of smart contracts

Smart contract technology finds applications in various scenarios.

Transaction assuranceEnsuring transactions between parties occur (e.g., purchase and delivery of goods).
Automated paymentsManufacturers can set up payments using smart contracts, streamlining supply chains.
Decentralized Finance (DeFi)Smart contracts power lending, borrowing, and yield farming platforms.
Identity verificationVerifying identities without relying on a central authority.
Real estate transactionsFacilitating property transfers and escrow services.
Supply chain managementTracking goods and ensuring transparency.
Insurance claimsAutomating claims processing based on predefined conditions.

Conclusion: Smart contracts

Smart contracts represent a significant advancement in contract technology, offering a transformative solution to traditional agreements. By leveraging blockchain technology, these self-executing contracts provide a decentralized, transparent, and efficient method for automating transactions and enforcing agreements without the need for intermediaries. 

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