February 14, 2019 Knowledge Center

A Beginner’s Guide to Smart Contracts


Smart contracts are computer code running on top of a blockchain. They consist of rules under which the participants agree to interact with one another. Once the predetermined rules are met, the agreement is automatically enforced.

They are self-executing contracts with the terms of the agreement between the buyer and seller directly written into lines of code; hence, no intermediary is involved. They are then distributed across a decentralized blockchain network.

Smart contracts allow non-identical, anonymous parties to carry out trusted trades and agreements without the necessity for a legal system, central authority, or any external enforcement mechanism. They make transactions traceable, transparent, and irreversible.

Uses of Smart Contracts

Trading

Traditional trading financial activities require an intermediary or a middleman; this makes the process expensive. Smart contracts remove the middleman of the trading finance by using either the trade payment transmission or the letter of credit method.

In payment transmission, a third party — usually a bank— transfers funds from the sender to the receiver using credit transfers. The letter of credit is a letter from one bank to another bank that guarantees the payment made to a person under specific conditions.

By eliminating these middlemen, the trading finance process is more straightforward, reliable, operative, and affordable for buyers and suppliers.

Employment Arrangement

All companies have a set of rules, terms, and conditions governing them. And often, employers and employees both have unwritten expectations of one another. Because of uncommunicated expectations, problems may arise. That’s when smart contracts step in. They help solve this problem by stating expectations clearly and giving companies the ease of constant revision of the terms of the agreement.

Storing Records

The smart contract comes equipped with the digitalization of the Uniform Commercial Code (UCC) filing — a letter that a creditor files showing interest in someone’s property. Its digitalization means they can save, release, and renew records automatically when needed. It also automatically allows records to be permanently removed by the law if the need arises.  

How Do Smart Contracts Work?

Just like a vending machine needs a few dollars to complete a transaction, the smart contract also requires an amount of cryptocurrency to be complete. The participants add this amount into the deal along with the information they want to keep on record. They also define the rules, terms, and conditions before the contract is made.

A smart contract can work as a single entity or with a group of other smart contracts. The single one will undertake tasks independently. However, with a group, the users can set a group of smart contracts together so they can rely on each other to complete tasks.

A smart contract has three main parts to work with:

  1. The digital signature of concerned parties:  A digital signature is a computer code generated and verified by public key encryption. It is attached to an electronically transmitted document to authenticate its contents and the sender’s identity.
  2. Complete access to the terms of agreement: The concerned parties must have access to the agreement and all the required information about it. There are no secret conditions or hidden details on the contract.
  3. Mathematically described terms and conditions: Suitable programming languages will set terms and conditions in the smart contract. Once a deal is ready, the concerned individuals have to accept and follow its rules and regulations to the letter.

In addition to this, there must be a reliable, open, and separate automated database. The smart contracts with all of these parts offer a great environment for it.

However, all advanced contracts’ data must come from a 100% reliable source. To guarantee this, they can use different advanced software and protocols like root SSL security certificates and HTTPS.

Blockchains Where You Can Process Smart Contracts

The blockchain is a distributed shared ledger that records and links transactions together to give the entire history of an asset. The blockchain has a trade added to it after a consensus protocol approves it. This ensures no counterfeits of the trade are made.

Also, each record has an extra layer of security. They cannot be changed and are transparent because all participants to trade have access to the same version of the truth.

Smart contracts on blockchain simplify the complicated process of involving several intermediaries because of a lack of trust among participants. This way, lenders can quickly decide whether to approve a participant’s credit application based on the information stored on a blockchain.

Then, a smart contract is created between the bank of the receiver, dealer, and lender so that once the funds are released to the dealer, the lender will hold the title, and repayment will be initiated based on the agreed terms. The transfer of ownership would be automatic as the transaction gets recorded to a blockchain.  Then, the participants share it among themselves and can review it at any time.

Conclusively, because smart contracts are automated and digitally operated, the participants do not have to spend time processing the paperwork trying to correct errors often found in documents written manually. Even more, smart contracts automatically execute transactions following preordained rules and the encrypted records of those transactions are distributed across participants. This leaves no room to question whether the information was fabricated for personal benefit.

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