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How Does a Smart Contract Work?

Smart contract

How Does a Smart Contract Work?

by | Smart contract

Ben Constanty

CEO, Smartlink

Disrupting online payments with smart contracts.

Blockchain technology has been around for over a decade now.

Within a short span of ten years, it has established itself as a revolutionary technology, providing higher efficiency, lower costs, transparency, and immutability.

Blockchain technology achieves cost and operational efficiency by removing the middlemen in any process. It uses smart contracts to automate tasks that would otherwise require multiple intermediaries.

So, what is a smart contract and how does a smart contract work?

What is a smart contract?

Smart contract - What is it?

Before answering how a smart contract works, let’s find out what is a smart contract.

A smart contract is a piece of code, run on a blockchain network, which is capable of executing itself as long as its underlying conditions are met.

There are three components of a smart contract:

  • Participants or signatories
  • Object of the smart contract (Asset holding value)
  • Terms of the smart contract (coded in a programming language understood by the underlying platform).

Before finding out how a smart contract works, let’s look into its origin story.

Origin of smart contracts

Nick Szabo

Nick Szabo, a cryptographer, in 1994, discovered that distributed ledgers are capable of self-executing agreements, otherwise called smart contracts.

However, the lack of a functional blockchain prevented him from implementing smart contacts.

Vitalik Buterin

Fast forward to 2015, Vitalik Buterin created Ethereum, the second most popular blockchain network/platform, with the capability of supporting smart contracts.

He revealed how a smart contract works on a blockchain network.

Since then, several blockchains have implemented the ability to support smart contracts, such as Waves, NEO, NEM, and Hyperledger.

Bitcoin could support smart contracts, but the specific functionality wasn’t explored to its full extent in the first version, especially when it comes to reading documents.

How does a smart contract work?

We’re ready to find out how a smart contract works.

  • The participants of a transaction enter an agreement to share or transfer ownership of a digital asset.
  • They agree on a set of terms, which are then coded within the smart contract using a programming language supported by the blockchain environment.
  • The digital asset (money, cryptocurrency, or a file) is placed in an escrow.
  • The participants initiate the transaction by signing or authorising it using their private key.
  • The smart contract is activated. It creates a transaction including the terms of the contract/agreement and transmits it into the blockchain network for confirmation.
  • The transaction is added to a new block pending validation. As soon as the validation is done, the transaction data is broadcasted to the entire network.
  • The local node receives the confirmation and thereby, commences the exchange of digital assets.

What are the benefits of a smart contract?

Example of a smart contract Ethereum

Example of a smart contract on Ethereum from ethereum.org

Now that you understand how a smart contract works, it’s time to look into the benefits of smart contracts.

Smart contracts offer:

  • Savings by cutting intermediary charges
  • Efficiency by automating the entire transaction
  • Accuracy by following a specific set of rules
  • Trustless environment to process transactions.

Smart contracts hold enormous utility across different industries. In fact, several international banks, organizations, are already using smart contracts because of their efficiency.

As the international ecosystem for blockchain technology continues growing, we’re likely to see rapid use of smart contracts by traditional industries.

Ben Constanty

CEO, Smartlink

Disrupting online
payments with smart contracts.

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