What is a Smart Contract?

To understand the concept of “what is a smart contract?” consider the purchase of a chocolate bar from a vending machine. The buyer deposits change then presses the button corresponding to the selection. That button, mapped against that particular slot, activates a lever in the machine to push out the candy. The transaction occurred without the need for a cashier or clerk. A smart contract is similar to a vending machine in that it eliminates the need for an intermediary. In this case, the vending machine is replacing a direct seller and allowing the consumer to make a purchase without a middleman. 

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So, What is a Smart Contract?

Smart contracts are self-executing contracts containing the terms and conditions of an agreement among peers. The terms and conditions of the agreement are written into a code. The smart contract executes on the Ethereum blockchain’s decentralized platform. The agreements facilitate the exchange of money, shares, property or any asset. There are two widely-used programming languages for writing Ethereum smart contracts – Solidity and Serpent. Solidity is a high-level programming language used for implementing smart contracts on the Ethereum blockchain platform. It enables developers to check the program at runtime rather than compile-time.

Traditionally, when two parties enter into a contract, they utilize the services of a trusted third party to execute the agreement. It’s been done this way for centuries. However, the introduction of smart contracts and its related technologies is automating what has been a laborious manual process. In this article, we will explore the technology behind smart contracts and how they can be put to use. First, let’s understand some of the key advantages of smart contracts over traditional contracts:

  • Intermediaries, Automation and Time Savings
    The sheer number of middlemen and intermediate layers involved in the execution of a traditional contract slows the process, often taking days or even weeks.
    Smart contracts can take just minutes, as they are automated and programmable, running on a computer under predefined conditions. There are no third parties involved.
  • Security
    Privacy and security are concerns with traditional contracts. With so many intermediate parties involved, security can be compromised at any stage in the process. Security is maintained through cryptography, public key and private keys when using smart contracts. Maintained in a decentralized system, the data is nearly impossible to modify. Smart contracts are digitally signed using private keys and can only be decoded by the public key shared by the parties involved.
  • Accuracy and Transparency
    Terms and conditions are predefined and pre-embedded in a smart contract. As soon as a condition is met, remittance occurs automatically and is recorded. If any remittance is involved with a traditional contract, it’s a manual process involving approvals workflows. Traditionally, transparency is dictated by the parties involved, peripheral entities and intermediaries. It’s an imperfect system. Smart contracts, however, are 100 percent transparent, available online 24*7*365. Anyone can review, audit and validate the archived transactions. Archiving is difficult with traditional contracts, as they are paper-based and maintained offline. Tracing transactions is cumbersome. Transactions in smart contracts may be traced right from the point of origin and archiving occurs automatically, creating a fully accessible history.
  • Cost  
    Traditional contracts are expensive when compared to smart contracts simply because all those middlemen must be paid. Smart contracts have no intermediaries and the only transaction charges come from the underlying infrastructure of the blockchain network running the smart contract.

Smart Contacts and Flight Insurance

Let's consider a real-life scenario in which smart contracts are used. Rachel is at the airport and her flight is delayed. AXA, an insurance company, provides flight delay insurance utilizing Ethereum smart contracts. This insurance compensates Rachel in such a case. How? The smart contract is linked to the databases recording flight status. The smart contract is created based on terms and conditions.

The condition set for the insurance policy is a delay of two hours or more. Based on the code, the smart contract holds AXA’s money until that certain condition is met. The smart contract is submitted to the nodes on EMV (a runtime compiler to execute the smart contract code) for evaluation. All the nodes on the network executing the code must come to the same result. That result is recorded on the distributed ledger. If the flight is delayed in excess of two hours, the smart contract self-executes and Rachel is compensated. Smart contracts are immutable; no one may alter the agreement.

Voting and Blockchain Implementation of Smart Contracts

Using blockchain in the voting process can eliminate common problems. A centralized voting system faces difficulties when it comes to tracking votes – identity fraud, miscounts or bias by voting officials. Using a smart contract, certain predefined terms and conditions are pre-set in the contract. No voter can vote from a digital identity other than his or her own. The counting is foolproof. Every vote is registered on a blockchain network and the counting is tallied automatically with no interference from a third party or dependency on a manual process. Each ID is attributed to just one vote. Validation is accomplished by the users on the blockchain network itself. Thus, the voting process can be in a public blockchain or it could be in a decentralized autonomous organization-based blockchain setup. As a result, every vote is recorded on the ledger and the information cannot be modified. That ledger is publicly available for audit and verification.

Smart contracts allow you to create voting systems in which you can add and remove members, change voting rules, change debating periods or alter the majority rule. For instance, you can create a vote for a decision within a decentralized autonomous organization. Rather than a central authority making a decision, a voting mechanism within the organization can determine whether the proposal is accepted or rejected.

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Blockchain Implementation of a Smart Contract and Crowdfunding

Ethereum-based smart contracts may be used to create digital tokens for performing transactions. You may design and issue your own digital currency, creating a tradable computerized token. The tokens use a standard coin API. In the case of Ethereum, there are standardizations of ERC 2.0 allowing the contract to automatically access any wallet for exchange. As a result, you build a tradable token with a fixed supply. The platform becomes a central bank of sorts, issuing digital money.

Suppose you want to start a business requiring funding. But who would lend money to someone they don't know or trust? Smart contracts have a major role to play. With Ethereum, you can build a smart contract to hold a contributor’s funds until a given date passes or goal is met. Based on the result, the funds are released to the contract owners or sent back to the contributors. The centralized crowdfunding system has many issues with management systems. To combat this, a DAO (Decentralized Autonomous Organization) is utilized for crowdfunding. The terms and conditions are set in the contract and every individual participating in the crowdfunding is given a token. Every contribution is recorded on the blockchain.

Ready to Learn More?

Blockchain is the underlying technology enabling the growth of smart contacts. Simplilearn’s Blockchain Certification Training was designed for developers who want to decipher the global craze surrounding Blockchain, Bitcoin and cryptocurrencies. You’ll learn the core structure and technical mechanisms of Bitcoin, Ethereum, Hyperledger, and Multichain Blockchain platforms. Simplilearn will provide the latest tools to build Blockchain applications, set up your own private Blockchain, deploy smart contracts on Ethereum and gain practical experience with real-world projects.

About the Author

Shivam AroraShivam Arora

Shivam Arora is a Senior Product Manager at Simplilearn. Passionate about driving product growth, Shivam has managed key AI and IOT based products across different business functions. He has 6+ years of product experience with a Masters in Marketing and Business Analytics.

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