Smart contracts explained



A smart contract ensures the enforcement of the terms of an agreement without a person acting as a mediator. Instead of the traditional text-based contract, the smart contract is a code that runs on blockchain technology.


Nick Szabo, the computer scientist and lawyer who first proposed smart contracts, compared it to a vending machine. The concept is like this:


If you put two dollars in the machine to buy a soda that costs one dollar, then the machine dispenses your soda and gives you back one dollar as a change. If you place less than the price of the soda, then the vending machine will not accept your payment and will not dispense the product.


There was no need for a person or a mediator to facilitate the transaction in both instances. Similarly, smart contracts follow the “if/when…then” principle.


One example is a smart contract between a project developer and investors.


When the smart contract receives the indicated amount of funds from the investors, the smart contract will then release the coins to the developer. If the developer fails to complete the project, the smart contract will return the coins to the investors.


Decentralized applications (dApps) bundle smart contracts together to perform sophisticated transactions such as trading and lending.


Benefits of using smart contracts


Trustless

Smart contracts are self-executing, which reduces and even eliminates human intervention. It carries out transactions without trusting third parties such as escrows.


Transparency

Smart contracts are stored on a blockchain ledger. Anyone in the blockchain can view all the terms and transactions.


Security

The use of cryptography in smart contracts makes transactions tamper-proof. Information cannot be changed or altered.


Accuracy and clarity

Traditional contracts often encounter errors because of manual filing. In the case of smart contracts, the terms and conditions have to be coded in the computer program.


Speed

Because intermediaries are not needed, smart contracts do not go through the traditional business processes such as document stamping and in-person meetings.


Cost-effective

The absence of middlemen in facilitating transactions means the parties involved can save on fees. There’s no need for lawyers, banks, and other agencies that require retainers or processing fees.


Uninterrupted

Once a smart contract is set, it cannot be halted or interrupted. The smart contract will follow the code’s timeline. In loans, for example, payment will automatically be collected on the indicated date.


Limitations of smart contracts

Flexibility

Smart contracts are transactional rather than relational. There’s no room for humanitarian or reasonable considerations.


Legality

While the core principles of traditional contracts are present in smart contracts, laws have yet to be created in most states to acknowledge if smart contracts are legally binding.


Error in coding

Loopholes might be present when a programmer commits errors in coding, which could also give way to hacks.


Use cases

Financial services

Trading activities without the involvement of a broker can take place using smart contracts. It can also automate the release of funds and collection of payments in a loan.


Real Estate

Properties can be tokenized on blockchains. Its ownership can be transferred if certain conditions set in the smart contract are met.


Healthcare and Insurance

Patients’ health records can be stored in the blockchain and accessed using a private key. Once enough data is collected and verified, an insurance claim can also be automatically executed.


Voting

Smart contracts can simplify the voting process without sacrificing security. The voter’s identity can be validated and the vote can be logged in the blockchain.


Copyright and royalties

Intellectual assets such as music and art are now being tokenized into digital assets called non-fungible tokens (NFTS). Smart contracts can be programmed to ensure that artists receive royalties for the sale and consumption of their works.


Closing thoughts:

The security and reliability of blockchain technology paved the way for smart contracts to have a wide variety of use cases. The promising future of smart contracts in the ease of doing business could inspire moves for improvement.


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