What are Smart Contracts? – A Complete Beginner’s Guide

What are Smart Contracts?

When you go online shopping, you are usually required to pay for the product before the seller ships the product to you. It’s all good when you trust the business to keep their word. 

While trust is important in business, it’s also risky. This is why large purchases, like a house or a car, require a legal contract that can protect both the buyer and the seller. This contract is backed by the government’s laws and law enforcement.

However, in the crypto space, trust and central authority cannot be relied on. Most blockchain networks like Bitcoin and Ethereum are decentralised, meaning that no transaction, currency, or any business activity is backed up by any central authority.

Luckily, smart contracts have the potential to solve this problem. Learn more about what smart contracts are, and how they work below. 

Smart Contracts Explained

Smart contracts are essentially computer programmes that can facilitate complex transactions in a decentralised ecosystem. Smart contracts function similarly to traditional legal contracts, in that there is a set of conditions that both parties have to agree on or to fulfill in order for the transaction to execute fully.

The way smart contracts work may sound complicated and technical, but actually, you may already have an experience with something that closely resembles a smart contract in your local area.

Have you purchased anything recently from a vending machine? Snacks, drinks, tickets, perhaps? The computer programme behind these vending machines work like smart contracts, which perhaps read something like this:

If money is inserted into the slot, then count the amount of money inserted, and enable product options whose cost does not exceed the money’s value.

If the user picks an option, then disable other options, and subtract the value of the money by the cost of the product. 

If the cost of the product is cheaper than the money inserted, then prepare change. Then release the chosen product and the change if applicable.

With this computer logic, there is no need for a human being to operate behind the vending machine (though any child would have thought about this at some point). 

The transaction, albeit complex with multiple IF statements and clauses, can execute perfectly, autonomously, and without human intervention. This is the goal of every smart contract in a blockchain network that supports them.

Uses of smart contracts 

With smart contracts, it’s possible to scale up to facilitate even more complex transactions. Here are some examples of smart contracts being used in the real world.

Decentralised exchanges

Easy Crypto is not a decentralised exchange, and behind the services that the website offers are a team of engineers and customer success specialists that work to ensure that we deliver as promised, and satisfy legal requirements.

However, transactions that occur in decentralised exchanges are not backed up by the legal framework, which is why smart contracts are essential, to make sure that the transaction is secure and fair.

NFT marketplaces

Non-fungible tokens (NFT) are tokenised products, like digital artworks or even representations of a real-world asset, that are traded on blockchains like Ethereum. Because this marketplace operates in a decentralised ecosystem, no central authority can intervene and regulate it, which demands the use of smart contracts.

Private records

Privacy is paramount in the Digital Age, but unfortunately, not many companies adhere to the privacy policies that the public expects. Blockchain has the ability to store private information, and smart contracts can provide the logic gateway that allows the right individuals or groups to access private records.

Logistics

A complex supply chain often relies on more than one group of people who manage and keep track of the movement of resources. Sometimes, these groups of people don’t necessarily trust each other, which raises the demand for external auditors. Smart contracts can work in such trust-less systems that require transparency. 

Read more: Introduction to VeChain, the cryptocurrency for logistics.

What are the Benefits of Smart Contracts?

Wherever smart contracts are used, they help parties involved in transactions reduce costs and expedite transaction settlement, without the need of third parties such as lawyers, escrow agents, or notaries.

More importantly, smart contracts remove the possibility for human error when settling complicated transactions.

If the terms of a contractual agreement are not fully met, there is no possibility that communication errors or lack of due diligence will result in a smart contract executing by mistake. This, therefore, makes smart contracts arguably more secure than traditional contractual processes managed by real people.

Related: What is Decentralised Finance (DeFi)?

The Future of Smart Contracts

The effect of reducing costs by eliminating the middleman cannot be overstated. This implies that businesses can become more productive and efficient, if they move away from the traditional way of dealing with suppliers, customers, and third-party intermediaries.

Market Research Future quotes that the “smart contracts market” is expected to reach US $300 million by 2023 at the rate of 32% CAGR. This also means that decentralised networks and cryptocurrencies that support smart contracts for various industries will be invaluable to the world economy.

Learn more: Introduction to Ethereum, the first network to introduce smart contracts.