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What Are Smart Contracts?

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What’s in the core? 

A smart contract is a self-activating contract with the agreement terms made between a buyer and a seller that are directly written into lines of code. The code and the agreement exist across a decentralized blockchain network. The code controls the transactions, and they become trackable and irreversible.

Smart contracts make it possible to have secure transactions and agreements that can be performed among anonymous parties without any central authority or the legal system. 

Once a smart contract is created, it exists on a blockchain. The blockchain is a public ledger that holds all of a cryptocurrency's transactions. Anyone can see the transaction information, but it doesn't influence the secureness of operations. Thanks to blockchains with smart contracts, anyone can build the whole system of decentralized finance (also called DeFi) that can run on their own without a central authority. 

 

How do they work?

Nick Szabo, an American computer scientist who's an inventor of a digital currency called "Bit Gold," proposed smart contracts mechanism in 1994, 10 years before the invention of the first popular cryptocurrency known as a bitcoin (BTC).

Szabo defined smart contracts as digital transaction protocols that perform the terms of a contract. He wanted to broaden the functionality of electronic transaction methods to the virtual realm. 

Szabo also proposed the performance of a contract for such assets as derivatives and bonds. He wrote in his papers that complicated term structures for payments can now be built into contracts and traded with low transaction fees, thanks to computerized analysis of these difficult term structures."

While a single smart contract is responsible for one action, numerous contracts can be tied together to manage more advanced tasks. That's the way decentralized applications (also called dApps) work, and they make smart contracts much more useful.

Let's have a look at how a dApp works, as an example, decentralized crypto exchanges. Such exchanges let users swap one cryptocurrency for another using various smart contracts.

Here's a brisk explanation of the process itself:

  • When a user requests a trade of USD Coin (USDC) for Ripple (XPR), then a smart contract will get the current price and provide it.
  • Once the user accepts the transaction and sends over the USD Coin, then a smart contract will send the Ripple. 

 

What are smart contracts used for?

Digital Identity

Perhaps, that’s the most obvious smart contract use case. It contains reputation, data, and digital assets. This option can also help protect the identity from data breaches. 

The internet empowers you to connect to numerous services, but simultaneously, sharing your identity with the companies helps them to map your identity. Smart contracts can help co-contractor to learn about the person without knowing their true identity or verifying transactions. This smooth KYC improves interoperability, resilience, and compliance with the help of smart contracts. 

High Securities

Smart contracts help to simplify and improve capitalization table management. That’s because there are no intermediaries between the parties, including security custody chains. It is also broadly used for dividends, automatic payments, liability management, and stock splits.

Cross Border Payments

Using a Letter of Credit can help to revolutionize international goods transfer and trade payment initiations. 

Smart contracts will definitely improve the liquidity of the financial assets, in return, improving the suppliers, buyers, and institutions’ financial capabilities.

Government

Smart contracts can serve the government to automate some processes. For instance, land title recording where the government can use to do property transfers. Using smart contracts in this field will reduce auditing fees and also improve transparency within the whole system.

Another option is holding electronic elections, using an early mentioned digital identity and electronic record filing.

Gaming

The global gaming industry is a vast ecosystem that continues to grow quickly. Developers make and release games, and players pay to play and interact with those games. Blockchain technology in gaming can empower players to hold the utility and value of in-game items and asset acquisitions in a more effective way.

Blockchain technology in gaming is commonly driven by NFTs, which are unique digital assets that represent in-game items. NFTs depend on smart contracts. These tokens are rare and indivisible. Together, these characteristics of blockchain in gaming have the potential to drive mainstream adoption and a more equitable value model.

You can save in-game purchases, sell them, or move them into other supported games. 

Building DAOs

In 2017 it was allowed to businesses to be incorporated and ruled using blockchain technology. That made it possible to start decentralized autonomous organizations (DAOs), which function, ownership, and compensation can be built into smart contracts. DAOs can save on administrative costs, including office space, hiring, and incentive structures that may not include formal employment contracts. 

Real Estate 

If you bought a house or another property using blockchain technology, you probably, saved a lot on hidden costs connected to closing fees, title transfers, and payments to a broker. Once a property is tokenized, the required record-keeping can be processed with smart contracts, which saves time and money for all participants. They say that smart contracts can benefit parties by straightforward rental agreements and complex credit or mortgage agreements, as well as warranties and insurance. By using smart contracts and blockchain in real estate, the need for legal counsel or other advisory services becomes less crucial, potentially cutting costs across the board.

Healthcare 

Here’s another industry that can embrace blockchain technology for trusty, transparent data sharing. How can that work? Blockchain technology may also be used by the integration of smart contracts and entire dApps designed to solve key points such as interoperability, identification, and authentication problems. 

 

Advantages of smart contracts

  • Completely autonomous

The major benefit of smart contracts is automation. To put it simply, that means that it doesn’t have any interruption, and a third party can’t make changes in the agreement and decision. This automation helps organizations to automate particular aspects of their business. It also resolves issues in some processes where trust is an important issue.

  • Safety

Smart contracts that are amazingly secure. It makes processes work in a secure way. The encryption also makes smart contracts work as intended. Smart contracts run on networks with immutable data which can’t be changed or altered. That’s why all the information is kept highly secure.

  • No interruption 

It means that once smart contracts start the operation, they cannot be stopped or interrupted by anyone.

  • Trusty

It's unnecessary to trust the parties to process a transaction. A transaction or a trade doesn't need trust as its integral part. The reason is that smart contracts run on a decentralized network, meaning that the whole system is trustworthy and fully encrypted. 

  • Low-cost

Smart contracts make your transactions more inexpensive. That's because of the removal of intermediaries from the process. That makes the transactions faster and also reduces the total cost. 

  • Rapid execution

The autonomous smart contracts process is much faster compared to the traditional way. As all the parameters are already outlined within the smart contracts, it's only necessary to match them before it starts executing.

  • Error-free

The only point is that smart contracts are coded in the right way so that they perform flawless and smooth. Imagine you filled in the documents and made a mistake. If you use a smart contract to do it for you, then it will be an error-free process. 

 

Closing thoughts

Smart contracts are innovative and useful in many ways. People are becoming devoted fans of blockchain technology and investing their money in cryptocurrency precisely because of smart contracts. 

They are definitely essential for the digital economy as they can provide automation for decentralized platforms and offer many different use cases covering almost all fields of people’s life.

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