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What Are Smart Contracts and How They Work

Eliminating 3rd-party middlemen from personal financial affairs, such as banks, was one of the ideas that spurred the appearance of FinTech-based solutions. The question of whether this purpose has been accomplished is still unanswered, but the rise of cryptouniverse has raised concerns about traditional fininstitutions and whether they can be changed by a single mechanism that fits more to the ongoing digital data reality. These discussions have given rise to smart contracts, also referred to as “Blockchain 2.0.”

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What Are Smart Contracts and How They Work

Eliminating 3rd-party middlemen from personal financial affairs, such as banks, was one of the ideas that spurred the appearance of FinTech-based solutions. The question of whether this purpose has been accomplished is still unanswered, but the rise of cryptouniverse has raised concerns about traditional fininstitutions and whether they can be changed by a single mechanism that fits more to the ongoing digital data reality. These discussions have given rise to smart contracts, also referred to as “Blockchain 2.0.”

The HowSimpl team has prepared an overview of what is a smart contract. Read on to figure out smart contracts definition and smart contract examples.

What Are Smart Contracts?

In the legal world, a contract outlines bilateral obligations between parties and legally binds them. If one person does not fulfill their duties as defined in the document, the other can seek compensation for damages through legal channels. Traditionally, such agreements require at least 3 parties: two for negotiation and one for enforcement.

Smart contracts are a “substitute” to traditional agreements that leverage blockchain decentralization and remove 3rd-party involvement. Once the obligations are satisfied upon, the program autonomously executes. These terms are then recorded on the chain, staying immutable—even its creator can’t alter it once established. This is how do smart contracts work.

They differ from traditional legal contracts in several key ways:

  • Immutability: Once deployed, they cannot be altered, as each node stores an identical copy.
  • Trustlessness: They operate independently, without reliance on external parties like lawyers or financial institutions. This autonomy ensures consistent outcomes, even in complex transactions, completed in seconds or minutes, compared to traditional contracts which could take much longer.

You don’t need to wait for hours or months or rely on an intermediary – this is a more attractive option than traditional contracts in certain scenarios.

What is Smart Contract Mechanics?

This technology utilizes code to proceed with negotiations between participants. They operate based on conditional logic, meaning that smart contracts in blockchain have the form of an “if/then” structure. For instance, consider this scenario: Person 1 loans Person 2 one Ethereum at a 7% interest rate, with Person 2 providing unspecified collateral, time frames – 3 months. The contract encompasses all the details. If Person 2 fulfills their obligations in a timely manner, the collateral is automatically returned; however, if Person 2 fails to repay, the collateral is released to Person 1.

Smart Contracts & Blockchain Ecosystem

This is the heart of Web3. These applications are scripted in tech stack like Solidity and Vyper, developed specifically for contract creation.

Let’s consider an Ether smart contract example using Golem (GNT), a website acting as a marketplace for computational resources. It allows users to request computational resources for a fee. Upon confirmation of payment receipt from the requester and task completion by the provider, the conditions are deemed met. This way, the requester obtains data from providers, and the payment in GNT automatically transfers from the requester to the providers offering their services. If the predefined terms are not fulfilled, the contract remains unexecuted.

Real-World Examples of Smart Contracts

You may wonder what is a smart contract in crypto. One notable use case in crypto projects is their integration into DAOs, where they govern the organization’s operations. The transparency inherent in DAOs ensures that all stages of decision-making, from proposal to documentation, are publicly accessible.

Another interesting use case is online retail. Here, node data defines the terms of purchase agreements. Transactions are recorded on the chain, with funds being transferred to the seller only after the buyer receives their order. This streamlined approach provides mechanisms for enforcing standards and penalties for subpar product deliveries. This way, it safeguards the interests of both parties.

Moreover, smart contracts streamline identity verification processes, which simplifies the submission of documents for licensing purposes and reduces confusion regarding authorization.

Further examples of what are smart contracts in crypto include their usage in ICOs, where they regulate token issuance by identifying and registering investors. They automatically allocate tokens post-registration.

Also, they find utility in crowdfunding initiatives and GameFi systems, where they enhance security and facilitate seamless payments between users.

One more smart contract example – fashion. You can explore KRWN Studio Case, a platform developed by the HowSimpl team creating the future of fashion which lies at the intersection of modern digital couture and age-old fashion traditions.

Overview of Pros and Cons

We can outline such benefits of smart contracts as:

  • Transparency. Parties can clearly discern the terms governing obligation fulfillment.
  • Speed. Asset exchange occurs promptly upon the completion of obligations by both parties.
  • Elimination of middlemen. There is no need to involve intermediaries.
  • Streamlined enforcement. Obligations can be enforced more efficiently through automation.

Challenges include:

  • Lack of flexibility. Parties cannot provide explanations for non-payment or negotiate deadline extensions.
  • Security concerns. Like any computer program, smart contracts may contain bugs, and there is a risk of exposure to computer viruses.
  • Implementation complexity. Not everyone possesses the necessary coding knowledge, let alone an understanding of the procedures required to draft a code.

How to Create Smart Contracts

The 1st step is to define the business requirements and project specifications. For example, specifying the amount of money required for each payment or determining the payment deadline.

The second step is deciding on a blockchain. Here are some factors to consider:

  • What type of blockchain do you need?
  • How secure is it?
  • Regarding scalability, can we rely on using our system on a large scale in the future?
  • Regarding compatibility, does this system work seamlessly with other platforms?The third step is writing code using Solidity or Vyper. 

The third step is writing code using Solidity or Vyper. 

Testing is 4th stage and it ensures that your technology works correctly.

Once you’ve tested your project and ensured its correctness, you can deploy code to the blockchain. In the future, to upgrade it, you will need to create a new version, while the old version will be unchangeable and still exist on the chain.

The Future of Smart Contracts in the Digital World

Developers have only begun to explore the full depth of possibilities offered by smart contracts at the core of blockchain technologies. The number of use cases for these technologies is growing exponentially, and many see their prospects in new areas where all operations are currently regulated by traditional contracts. Here are some potential uses of smart contracts explained: mortgages, digital identity management, supply chain logistics, trading on the stock market and securities, organ distribution lists for transplantation, property rental and leasing, and so on.

Write Your Smart Contracts with the HowSimpl Developers

Thinking of an interesting blockchain project based on smart contracts? Tell us your idea, and we will create secure and efficient blockchain-based smart contracts tailored to your project’s unique requirements. Our blockchain specialists provide comprehensive blockchain solutions including the development of smart contracts, NFT marketplaces, streaming service development, and much more. Contact us today for a free consultation.

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