What Is a Smart Contract and How Does It Work? A Beginners Guide

Smart contract is a contract that automatically executes its terms when the conditions are met. It is now being used in various industries, especially crypto. Smart contracts enhance the safety and security of transactions on various blockchains like Bitcoin and Ethereum. Here, you will find a detailed explanation of smart contracts and their applications.  

What is a Smart Contract?

A smart contract is a computer program consisting of a code that automatically executes the agreement when the predetermined conditions are met. It is stored on a blockchain, and the contract becomes irreversible once the transactions are complete. 

Since smart contracts execute the transactions only under certain conditions, they are tamper-proof and can be trusted. By circumventing the need for a middleman, smart contracts boost operational efficiency and drive down transaction costs.

The decentralized nature of blockchain ensures that smart contracts are less vulnerable to malicious attacks. Furthermore, they are helpful in automating the workflow. 

What are the features of Smart Contracts?

Smart contracts distinguish themselves from traditional contracts with the help of their various features, and they are:

• Immutable: Once the smart contract is entered into the blockchain and deployed, it cannot be changed or altered.
• Customizable: Before the smart contracts are deployed, developers can customize the conditions according to their preferences. 
• Transparent: Anyone on the blockchain, whether they are participating in the smart contract or not, can view the smart contract code because the blockchain is a publicly distributed ledger.
• Autonomy: The smart contracts are made by the programmer and shared between various parties. They are executed through the nodes of the blockchain network, eliminating the need for intermediaries.
• Trustless: Smart contracts are executed automatically when the conditions are met, eliminating the need for third parties to verify.
• Distributed: Smart contract conditions are distributed throughout the network, ensuring that a single party cannot change the contract. Furthermore, they only perform functions they are designed to do.

How does Smart Contracts work?

Smart contracts work by following a simple logic: “if/when….then….” For instance, the conditions of the contract would be if A event happens, then immediately execute Y action. A developer can set multiple conditions for a single smart contract to execute, and one application can have multiple smart contracts to support a set of processes. 

Once the pre-set conditions are met, a network of nodes will help execute actions like sending notifications, releasing funds to one party, and more. Once the actions are complete, the blockchain is then updated.

How to Create a Smart Contract:

Now, let’s discuss the steps involved in creating a smart contract on the Ethereum network.

1. Create a MetaMask Wallet: 

To connect to the Ethereum mainnet, you need a MetaMask wallet. Open your Chrome browser and download the MetaMask wallet. Install the wallet on your browser and enable it. Once the installation process is over, you will see its icon on the top right corner of the browser page and click it. A MetaMask page will open in a new window on your browser.

Select “I agree” in the terms and conditions section and click “Create Wallet.” You will be asked to create a password, and once the password has been created, MetaMask will send you a secret backup phrase restoring and backing up the account. Note down the phrase and make sure to keep it safe or in an encrypted hard drive. Keep in mind not to disclose the password and phrase to anyone. Once the setup has been completed, you can connect to the Ethereum mainnet.

2. Choose the Test Network: 

MetaMask wallet will offer many test networks that can be used to test the smart contract you are building. Choose any one of the available test networks:

• Rinkeby Test Network
• Goerli Test Network
• Kovan Test Network
• Robsten Test Network

3. Add Testnet ETH to the Wallet:

It is always a good idea to have Testnet ETHs in your wallet because once you are ready to test the smart contract, you will need Ethers. The process of adding Testnet ETHs isn’t complicated, all you need to do is click on “Deposit” and “Get Ether” under the Test Faucet.

Click on “Request one ether from the faucet” to proceed, and 1 ETH will be added to your wallet. There is no limit to the number of ETH you can add to your wallet in the test network. 

4. Use the Remix Browser To Write The Smart Contract:

You can use the Remix editor in the Remix Browser IDE to write the smart contract code in Solidity. The remix browser is used to write smart contracts because it offers several features and is considered the best option for writing basic smart contracts. Its features include:

• Static analysis
• Functions with injected Web3 objects
• Syntax and error highlighting
• Various warnings like unsafe code, gas cost, whether the function is constant or not
• Integrated testing and development environment
• Integrated debugger
• Deployment on MetaMast or Mist

5. Create a .sol Extension File:

Launch the Remix browser, and on the top left side, you will see a + icon click on it to create a .sol extension file. This is to make sure all programmed files are compatible with Solidity.

6. Create the Smart Contract Code:

Enter the smart contract code on the extension file and choose a version of the compiler from the Remix browser to compile the code.

7. Deploy Your Smart Contract:

Deploy your smart contract code on the Ethereum test network by selecting the “Deploy” button. Once the transaction is done, you will find the smart contract address on the browser’s right-hand side.   

History of Smart Contracts:

In 1994, an American computer scientist called Nick Szabo was the first person to propose Smart Contracts. He defined them “as computerized transaction protocols that execute the terms of a contract.” Furthermore, in his paper, Szabo proposed the development of new securities by combining bonds and derivatives while supporting smart contracts for payments.

The first ever smart contract protocol with a set of conditions was used on the Bitcoin blockchain in 2009. With the development of the Bitcoin blockchain, smart contracts evolved into another type called multi-signature transactions. 

The next major revolution of smart contracts came with the release of the Ethereum whitepaper in 2013. When the Ethereum blockchain was launched in 2015, it brought along with it a programmable smart contract. The main distinction between a smart contract on the Ethereum blockchain and other blockchains is its robustness and efficiency in executing complex transactions. 

What are the uses of Smart Contracts?

The main function of smart contracts is to execute agreements. Its applications extend to a wide range of industries due to its varied features.   

1. Entertainment Industry:

Leveraging smart contracts in the entertainment industry can make paying royalties easier. It is useful in resolving royalty disputes in OTT platforms, helping lesser-known artists gain small but regular payments. For instance, a singer can store their song in the blockchain and embed a smart contract to that block. Royalties will be automatically credited to the singer’s account whenever the song is used for commercial purposes. 

2. Real Estate:

Smart contracts can reduce the time it takes to handover property ownership. For instance, once the buyer pays the complete amount to the seller, smart contracts enable an immediate transfer of control of the asset to the buyer. 

3. DeFi Applications:

DeFi applications empowered by smart contracts can provide financial services like options trading, exchange trading, borrowing, lending, and more without the need for an intermediary. They can manage the funds in escrow and distribute them when predetermined conditions are met.  

4. Gaming Industry:

The video game industry has been growing exponentially with the onset of blockchain technology. In the gaming ecosystem, smart contracts are used to provide a tamper-free environment in blockchain-based games. Furthermore, they enable players to securely transfer digital assets guaranteeing transparency and ownership.

5. Supply chain management:

Smart contracts operate autonomously, executing actions only when predetermined conditions are fulfilled, eliminating the necessity for third-party supervision.

6. Government Elections:

Each vote is encrypted and ledger-protected, making it extremely hard to decrypt the address and change the votes. So, there’s a minimum chance of voter manipulation when voting using smart contracts. Furthermore, incorporating smart contracts into online voting systems has the potential to enhance voter turnout.

7. Healthcare Industry:

Implementing smart contracts in the healthcare industry can reduce the number of insurance fraud cases. For instance, when a person claims insurance, smart contracts validate all medical data and authorize a payout only when the information is true and accurate.

Advantages of Smart Contracts:

• Smart contracts automate the execution, enhancing speed and efficiency and saving valuable time. 
• Eliminates the need for third-party intermediaries and builds trust and transparency with customers. 
• Everyone on the blockchain can review smart contracts, making them extremely hard to modify.
• Blockchain is replicated and synchronized. It also means all the data in it are replicated, and in case of data loss, the original data can be easily recovered.
• It has high fault tolerance because no single entity is controlling the blockchain. 

Disadvantages of Smart Contracts:

• Smart contracts are developed by humans, and any human error in code can lead to a breach in security. 
• There is no regulatory clarity for smart contacts making it difficult to define a set of standards.
• No changes can be made after the contract is deployed. A new smart contract has to be developed even if a small change is required.
• Blockchain cannot process real-time data, making it hard to deploy smart contracts for applications that require timely data to process a transaction.   

Conclusion:

Smart Contracts are undoubtedly a step forward when compared with traditional contracts. It helps save time and money while reducing the need for human involvement. Due to their irreplaceable advantages, smart contracts are already being used in crypto, banks, and other sectors.

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