A smart contract is a set of computer code running on the blockchain that automatically executes an agreement when the agreed terms are met. They eliminate the need for intermediaries, reduce costs and improve security.
Example: think of a vending machine. You enter money (the condition) and it automatically delivers the product (the result). Smart contracts work in the same way, but in the digital world.
Key features of smart contracts
- Automation: Smart contracts run automatically when specified conditions are met.
- Transparency: All contract information is visible on the blockchain.
- Security: Using cryptography, smart contracts are difficult to manipulate.
- Efficiency: It reduces the time and cost of associating with traditional intermediaries.
How does a smart contract work?
At the heart of a smart contract is the blockchain, a decentralized network that records all transactions. Here’s a step-by-step example of how it works:
- Define the agreement: the parties set the terms of the contract (e.g. “I pay 1 ETH for product X”).
- Encoding: The terms are written as smart code and implemented on the blockchain.
- Automatic execution: When the terms are fulfilled, the smart contract is finalized (e.g., product X is automatically delivered when payment of 1 ETH is confirmed).
- Transparent record: Everything that has happened remains transparent and publicly accessible on the blockchain.
Note: Popular blockchains like Ethereum are the most widely used platforms for smart contracts.
Benefits of using smart contracts in crypto
Adopting smart contracts in the cryptocurrency world comes with a lot of advantages:
- No middlemen: Elimination of additional fee collections.
- Fast process: Processing time is almost instantaneous.
- Lower costs: Fewer middlemen means fewer fees.
- Robust security: Blockchain ensures the code is immune to malicious tampering.
- Diverse applications: From simple procurement to complex financial systems.
Real use of smart contracts:
- DeFi (Decentralized Finance)Platforms: Basics from yield farming or digital lending often use smart contracts.
- NFTs(Non-Fungible Tokens): Protecting the copyright of a digital work.
- Peer-to-Peer (P2P) buying and selling: Direct transfers between users without centralized authority.
Where are smart contracts used today?
1. In decentralized finance (DeFi)
DeFi apps allow users to borrow, collateralize their funds or earn interest without depending on a bank. Ethereum is the most popular blockchain that hosts DeFi apps based on smart contracts.
2. Creating and selling NFTs
For artists, game developers and collectors, smart contracts allow you to create and sell NFTs. Buyers are sure they’re getting a genuine asset, and sellers can protect their copyrights.
3. Supply chains
By removing red tape, smart contracts create complete transparency in supply chain management. Businesses can better track the provenance of goods.
4. Real estate and large transactions
Smart contracts have simplified the process of real estate transactions. They eliminate red tape, and funds are only transferred on a self-interested basis when all parties honor their commitments.
Limitations and challenges of a smart contract
Although a smart contract offers many benefits, there are also some limitations:
- Miscoding: An error in contract coding can pose financial risks.
- Lack of regulation: By eliminating human intermediaries, there is no easy recourse in disputes.
- Few developers: Creating smart contracts requires blockchain expertise (e.g. Solidity for Ethereum).
To overcome these limitations, it is essential to collaborate with experts or use platforms that offer intuitive support.
Why use smart contracts?
Smart contracts are the future of automated processes, and their continued applications are growing. What’s more, their use is not just reserved for large companies. More and more platforms dedicated to promoting cryptocurrencies are making usage accessible to the general public. If you want to learn more about how smart contracts work, we invite you to explore the Abarai blog, where you will find articles on this topic. For information on cryptocurrency pricing you can visit our dedicated page.