A contract is an agreement that exists between two or more people. On the other hand, smart contracts are programs or codes that carry out the terms of an agreement. However, the workings of traditional contracts are prone to error and distrust from one or both parties due to the human mistakes of a third party.

With smart contracts, the user's focus shifts to a more decentralized way where their contracts are self-executed using blockchain technology.

This article will guide you on a simple approach to understanding smart contracts, their importance, how they function, and their use cases.

What are smart contracts?

Smart contracts are programs that exist and run on the blockchain. They function when specific conditions are met. These codes are specified in a contract and can function when the preconditions of that contract have been met.

We can liken smart contracts to a video game. Here, the player cannot move on to the next level until the previous level has been completed. This is possible because a program has been stored in the game that allows for levels to be changed only when certain conditions are met.

Smart contacts are built on the if-and-then rule. To illustrate, “if Joe can meet the cutoff mark set for his entrance exam, then he can be offered admission to study medicine.” However, if he’s unable to meet up, the contract that was laid out will become null and void.

Anyone can create smart contracts on a blockchain. This simply means that, unlike traditional contracts written with a pen on paper by a specific individual, smart contracts are lines of code that can be executed when the terms of an agreement have been reached. The lines of code are a programming language, and one widely used language is Solidity.

These contracts run on blockchain technology, like the Ethereum network. Each node connected to the Ethereum network is given an exact copy of the previous and most recent smart contracts stored on the blockchain.

For instance, in the transfer of funds to a participant, Participant A transfers digital assets to Participant B as a form of lending. This asset is stored on a smart contract. An agreement on the terms is reached between the two parties. The transaction is notified to all other nodes in that network, with the codes being distributed. Then, all nodes verify the transaction, and the smart contracts are self-executed.

Since a smart contract exists on a blockchain, it is a ledger distribution. Thus, it is difficult to alter or lose codes stored in a smart contract: they are immutable. Blockchain technology is the powerhouse of a smart contract.

This is not to mention the potential risk associated with smart contracts as a result of errors in code or vulnerability to attacks. To protect a smart contract, proper attention and assessment of programs must be given. Before the contract goes into the blockchain, it must be verified on an:

Individual level, group stage, testing

Benefits of Smart Contracts

• SC builds trust among participants. This is possible because of its decentralized nature

• It eliminates the role of a third-party

• Its mode is transparent and verifiable for all to see because it is published on a blockchain

• It is secured. SC, when recorded on a blockchain, becomes immutable

• SC is executed faster when conditions are met. This is possible because it is digital and not traditional

• It is better able to handle complex transactions at once

Step-by-Step Explanation

1. The two parties involved in smart contracts agree on certain terms and conditions. That is, they agree on a condition that must be met before a contract can be executed. The contract also specifies the consequences involved if the conditions agreed upon are not met

2. These terms and conditions are translated into a series of lines of code using a programming language

3. We then move the pre-created and secured smart contract to the blockchain. It is distributed evenly to all nodes in that network. The benefit is that it protects the parties' interests and ensures trust among the parties involved.

4. While on the blockchain, the smart contracts are monitored by all nodes connected. The transaction takes place on the blockchain. Hence, the smart contract monitors the transaction. It ensures that the conditions the parties agreed upon are met. Thus, conditions (if/when) are like triggers.

5. The smart contract executes on its own when it satisfies all conditions. The nodes connected verify the execution of the contract. Then, it is recorded and distributed on the blockchain

6. The outcome of the smart contract, whether successful or not, is published on the blockchain and made public for all to see. All nodes have a copy of each of these smart contracts.

Use Cases of a Smart Contract

We must establish that smart contracts cannot function without blockchain. Smart contracts are the building blocks of blockchain networks. Now, let’s unravel the mystery behind smart contracts and give them practical usage.

Supply Chain Management

In a traditional market setup, SCM manages the flow of goods, from getting the raw materials to their delivery to the final consumer. That is why those involved as traditional marketers do what is called market mapping and stomping to see the end goal of the company’s product in the hands of the final user.

A traditional SCM involves a distributor who functions as the middleman. They purchase the foods from the manufacturer in bulk and sell them to retailers and consumers at a selling price.

In the Web3 ecosystem, SCM eliminates the role of an intermediary. Using smart contracts, transactions are based on an end-to-end supply chain. The flow of goods and transactions is recorded on the blockchain.

This way, its flow can be monitored and viewed by all nodes in that network. With SCM, the movement of goods and the flow of cash are viable, transparent, trustworthy, and verifiable by all nodes.

SCM handles complex transactions and data by simplifying them and making them visible for all to see. Because of the larger amount of data they can accommodate, SCM often collaborate with the cloud to enhance the performance of the chain

Decentralized Finance (DeFi):

Here, it involves the borrower and lender. A lender wishes to lend out its money and goes to a lending pool to do so. However, the lender specifies certain conditions, such as the amount paid in full with interest, the specified date and time frame, and so on.

The smart contract copies this and holds the funds from the lender. Then, a borrower decides to borrow a part of the asset. He/She will agree to the lender's terms and provide collateral, which the smart contract will also hold.

It’s essential to note that there are no human third parties involved. The transactions take place on a smart contract. Then, the lender agrees on the borrower's condition, and the smart contract executes itself by releasing the asset to the borrower.

When the borrower fails to fulfil the part of the agreement, the smart contract releases the collateral, usually in cryptocurrency, to the lender.

Others include:

Mortgage

Logistics

Real Estate

Healthcare

Insurance

It is important to note that before a contract is executed on the blockchain, an important condition must be met. That is the payment of a gas fee. This is the fee that handles transactions, whether simple or complex. The more complex the transaction, the higher the gas fee.

Conclusion

The presence of Web3 incorporates decentralization, blockchain, crypto, and smart contracts. Smart contracts are responsible for the functionality of the blockchain. However, the Bitcoin network does not use smart contracts.