What Are Smart Contracts in Blockchain and How Do They Work?

Crypto Mining, Blockchain

Smart contracts are essential components of the blockchain network. They are vital for secure, transparent, and decentralized transactions. Every application or software that runs on the blockchain requires a set of smart contracts to operate properly. 

Popularized by the Ethereum network, smart contracts are mainly utilized for cryptocurrencies. But they have greater potential and are likely to be adopted in different industries. So, what are smart contracts in blockchain? What makes them so efficient and unique? 

The definition of smart contracts 

A smart contract is a digital analog for traditional agreements. Even though it’s quite different from written paperwork, it does follow the same concept. To be more precise, it includes a set of rules that should be satisfied to trigger execution. 

Unlike traditional agreements, smart contracts are computer programs that operate using code. They are fully automated and eliminate the need to have intermediaries. The contract will be triggered on its own when the determined conditions are met. 

Traditionally, you would need to contact your bank to approve a cross-border transaction or to transfer a large amount of money. Thanks to smart contracts, you can execute any payments on the blockchain without third-party involvement. This means that you can send digital money from the UK to New Zealand in seconds. You can also pay salaries or distribute funds without external approval. 

How do smart contracts work in blockchain? 

Similar to traditional agreements, smart contracts include conditions that determine when and how the contract will be enacted. They are structured with ‘if…then’ phrases that trigger automated execution. 

For smart contracts to operate properly, the involved parties should first agree on the specific terms. Such digital contracts are usually quite detailed about each condition. They include possible limitations and the scope of operation, which eliminates any misunderstandings. Once the parties agree to the conditions, they can transfer the task to the developers. 

Developers will review the conditions and encrypt them in the code. They will program the smart contract to self-execute whenever those terms are met. At this point, it could be ready to be deployed to the blockchain. However, there’s one more essential step: a smart contract audit. You see, it’s impossible to modify or reverse smart contracts once they get to the digital ledger. Even the tiniest mistake in the code could present a significant vulnerability. Therefore, smart contracts are reviewed thoroughly before they come into action. 

After the revision, smart contracts can be deployed to the blockchain and the transaction will be recorded. The network will update all of its computers with the new transaction. 

Types of smart contracts in Blockchain 

Even though smart contracts can be different depending on their purpose, all of them can be combined into three main categories: smart legal contracts, Decentralized Autonomous Organizations (DAOs), and Application Logic Contracts (ALCs). 

Smart Legal Contracts

Smart legal contracts are basically the same as traditional agreements, yet they operate on the blockchain. When structured and executed correctly, they have just as much legal power as traditional contracts. If any of the parties fail to fulfill the pre-determined conditions, they will have to face legal action. 

Since smart legal contracts cannot be altered after being released, they acquire more trust among the parties. This, in turn, reduces the necessity of court dispute and settles the matter quickly. 

Decentralized Autonomous Organizations (DAOs) 

DAOs are blockchain communities that gather around the same ideas and agree to satisfy certain rules. This agreement is enforced with multiple smart contracts and obliges each member to complete their task. DAOs don’t have a single authority and, consequently, they are managed by the included parties themselves using smart contracts.  

Application Logic Contracts (ALCs)

ALCs are a more complex form of smart contracts as they have application-specific code that interacts with other smart contracts or programs on the blockchain. Typically, ALCs are used to merge the Internet of Things (IoT) with blockchain as they facilitate communication between various devices. 

Along with blockchain technology, smart contracts can help simplify processes that are way too complicated. They can find the broadest application in the legal system, yet their uses aren’t limited to the law. They can be safely used in any industry that requires agreement between the parties. Be it simple transactions, buying a house, or voting – smart contracts will bring more change in the future. 

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