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12 Apr 2021

Smart Contracts in Blockchain and its Working – 2021

Farheen Shaikh

Cryptocurrencies around the world have become more popular than ever before. Their adoption in everyday life and in business can be attributed to a very significant use case: smart contracts. But what are smart contracts and how do smart contracts work?

A smart contract is the blockchain version of an automated process. They are a use case of the blockchain technology developed to make large transactions easier and faster. A smart contract in blockchain also makes transactions more secure by removing the role of intermediaries.

What Is A Smart Contract Used For In The Real World?

Let’s understand it this way.

For instance, an insurance company could use smart contracts to release claimed money to you automatically, without having to pay commissions to an agent. By automating the process and working on a blockchain ledger, the company and you, the user, are both assured of the outcome of the transaction at every point.

Smart contracts are nothing more than pieces of code, carefully designed by programmers. The usage of a smart contract in a blockchain is beneficial because it is reliable, transparent, and irreversible. Smart contracts are executed automatically by the blockchain when all predefined conditions are met.

Smart Contracts Blockchain Explained

But, you need more than that to understand exactly how smart contracts work. Let’s tackle that with an example. Say you want to buy a house from a seller with the help of a smart contract. Here’s how that would work:

  • Suppose you pay 2 BTC for the house to the blockchain, in return for a digital key to the house from the seller. The smart contract is designed in a way that lets it complete the transaction only when both parties have done their part on time.
  •  You pay the amount to the seller through the contract. Similarly, the seller uploads the digital key to the house through the contract as well.
  •  The contract recognizes and verifies the payment as well as the digital key automatically. When everything seems to be in place, the transaction is made on the pre-decided date. The seller gets access to the money you paid and you get the digital key to the house.
  •  However, at the date of the transaction, if the seller has not uploaded the key yet but you’ve paid the money already, your money gets returned to your wallet because all conditions for executing the smart contract were not met. In this way, the contract ensures that every party’s resources are secured.

Here, there are several advantages:

  • Security – Large sums of money do not get lost in transactions because no intermediary is involved in handling the money
  •  Accountability – Every party adheres to strict deadlines in terms of putting up the money or transferring the digital key, so there are no delays
  •  Low-cost – No added expense of paying intermediary parties; in this case, real-estate brokers or realtors
  •  Speed – The money is returned promptly to the buyer without delay
  •  Accurate – There is no scope for theft or reversal of transactions because the smart contracts work on an open blockchain ledger with thousands of nodes verifying them every second

Other Applications

There’s a lot more to smart contract applications that are apparent at first sight. For example, they can be used to regulate the health insurance sector to reduce fraudulent claims. Smart contracts could ensure that funds were released for health-related expenditures only when hospitals verified them on the blockchain to reduce the risk of insurance theft.

Another real-world example of a potential smart contract is transparent voting. Free and fair elections are the cornerstone of every democracy. Smart contracts can ensure that votes are counted accurately, they are not tampered with, and no technical manipulations can be made in the favour of any one party. Smart contracts could also make maintaining voter lists easier and their verification during elections faster.
What are the types of smart contracts?

Now that you know how smart contracts work, you must know that there are different kinds of contracts for different purposes. For example:

  • Smart legal contracts can be used to automatically enforce a legal document without needing intermediaries like law firms or attorneys to facilitate the transaction
  • Decentralized Autonomous Organizations are full-fledged companies that work as databases for people who need reliable and credible information for huge escrow transactions
  • Application Logic Contracts are smart contracts that are used at scale to bring down charges that come with repeated and automated transactions

These different types of smart contracts are used in different scenarios to facilitate different types of transactions, all with the help of some predefined commands and conditions.

Which Currencies Support Smart Contracts?

Ethereum is currently the most popular smart contract blockchain network that supports smart contracts. However, if smart contracts are to become the future of all transactions, there is room for a lot of improvement in ETH. Even Vitalik Buterin, the creator of Ethereum, doubts its current abilities by saying, “Scalability [currently] sucks; the blockchain design fundamentally relies on bottlenecks where individual nodes must process every single transaction in the entire network.” There are other currencies like Cardano and Ethereum Classic that are working to enable smart contracts in their networks, just like Ethereum.

Bitcoin, the largest and by far the most widely used cryptocurrency, does not offer support for smart contracts…yet. There has been speculation that an upgrade to the core fundamentals of Bitcoin called Taproot is underway. The implementation of Taproot is expected to bring smart contract abilities to Bitcoin as well, making it one of the most attractive and versatile cryptocurrency options out there.

Are Smart Contracts The Future?

Smart contracts are the newest innovation that tries to make transactions easier. But that’s not all. The secret to its potential success lies in its scalability and versatility as a technology. Just like other applications for the blockchain started becoming popular when cryptocurrencies emerged, smart contracts can be used in hundreds of ways going forward.

For example, the use of blockchain as a basis for NFTs and their sale became popular only when the blockchain was verified as a reliable technology by the emergence of cryptocurrencies. Similarly, with the adoption of certain types of smart contracts, probably in the real estate and financial sector, other uses can emerge gradually.

Currently, they’re being used to remove the dependence on lawyers to facilitate legal contracts. Smart contracts are also being used to automate behaviours and decisions, making risk assessments and auditing easier than before.

The usage of smart contracts also looks promising when considering their use in IoT appliances like smart locks and wallets. In the supply chain scenario, they can be used to physically approve merchant transactions depending on various factors like the integrity of goods and the timely payment of invoices.

The potential uses of smart contracts in blockchain are endless and all that’s left to see is how soon they can be converted into an integral part of daily life.

Be Part Of The Revolution

Buy Crypto With Just ₹100

The world is gradually adopting crypto in everyday life. With the use of smart contracts, it is only a matter of time before every major transaction gets facilitated by the blockchain. With a major technological revolution coming, make sure you benefit just as much as the others.

Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

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Farheen Shaikh

Content Writer

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