Smart contracts explanation: what are smart contracts?

Many people find the technology behind cryptocurrencies difficult to understand. This is not strange, since many terms that are used can cause confusion. One of the terms that many people find difficult to understand is the smart contract. Since smart contracts play an important role in well-known projects such as Ethereum and EOS, it is necessary to explain this in more detail. To help you on your way, we will answer the question: what are smart contracts?

What are smart contracts? – function and meaning

Later, we will look at the most important advantages that smart contracts bring. But before we do this, it is a good idea to first zoom in on the question of what smart contracts actually are. It is a bit technical, so it is important to really pay attention. Smart contracts help you exchange money, property, shares or anything else of value in a safe and above all fast way. By means of smart contracts it is possible to make the services of an intermediary completely superfluous. Everything happens in a direct manner with the parties involved.

Smart contracts are, in fact, nothing more than special rows of codes stored on a blockchain. They are executed automatically when predefined conditions are met. At a fairly basic level, they are programmes that execute as they are set by the people who developed them. The advantages of smart contracts are particularly evident in the business world. They are often used by companies who would like to enter into an agreement with another company. We will come back to this in a moment.

smart contract

The role of blockchain

As you have read above, the blockchain plays an important role in smart contracts. Although we cannot explain the entire blockchain in this article, it is useful to take a brief look at how the blockchain works. The blockchain is a shared and fully distributed ledger on which transactions are digitally recorded. These transactions are then all linked together. This ensures that they can map out the entire history or origin of an asset. A transaction is only added to the blockchain after it has been validated using a consensus protocol. As a result, it is the only version of the real contract.

Each record is also encrypted to make it a little more secure. Blockchain is said to be “immutable” because the records cannot be changed and are transparent because all participants in a transaction have access to the same version of the truth. This therefore means that contracts are no longer subject to fraud. People who try to cheat someone else by sending the wrong contract will unfortunately come home empty-handed. This is also one of the biggest advantages that smart contracts have to offer.

How do smart contracts work exactly?

Smart contracts work in a rather special way. The simplest way to describe smart contracts is to think of a vending machine. Normally, you go to a lawyer to pay him for the services provided after everything has been delivered. With smart contracts, this is done slightly differently. Here you pay for the services with cryptocurrency in a kind of vending machine. The contract that you need is then immediately displayed in your account.

But that is not all: the smart contracts not only define the rules and penalties surrounding a contract in the same way as a traditional contract, but also automatically enforce those obligations. So, in effect, you have bought a kind of ready-made contract that you can immediately apply to an agreement. How simple can it get?

Application in practice – operation of smart contracts

Let’s make it a bit easier by using a real-life example. Let’s say you rent a flat from person A. You do this via the blockchain by paying in a cryptocurrency. You get a receipt which is kept in our virtual contract. Person A gives you the digital access key that is delivered to you on a certain date. If the key doesn’t arrive on time, the blockchain releases a refund. If Person A sends the key before the rental date, the function holds it and releases both the money and the key to you and me when it’s time. This ensures that everything can be transferred fairly. If you send a certain amount of money in digital currency, you get the key to the flat.

The document is automatically cancelled after the time. The code cannot be changed by one of us without the other’s knowledge. If anything is changed, both parties are notified. Although it is more complex in reality, this is a basic explanation of how smart contracts can be used in the real world. You can see that it has many advantages compared to a normal rental contract for a house. By the way, this does not only apply to the world of rental contracts, but also to all possible other forms of service provision.

What can you use smart contracts for?

Some people wonder what smart contracts can actually be used for. You can use smart contracts for all kinds of situations. From sending financial derivatives to drawing up insurance premiums, the possibilities with smart contracts are unprecedented. To give you some insight into the possibilities, we have listed a number of sectors below which are suitable for the use of smart contracts.

The automotive industry

As you know, a lot of innovation is taking place in the car industry at the moment. One example is the rise of the self-driving car. Although it will be some time before they are on the road in large numbers, it is true that smart contracts could play an important role in this market. The smart contracts can bring a kind of ‘oracle’ into play that can detect who was at fault in a car accident. They can also keep track of a lot of other useful data for the insurance company, for example.

Smart contracts would allow a car insurance company to calculate different rates based on where and under what circumstances customers use their vehicles.

The government

There are many questions about whether it is safe to vote over the Internet or by post. Perhaps smart contracts can be used to solve certain problems we encounter in governments. Committing fraud with voting on the blockchain is practically impossible. Nobody has that much computing power, which is why smart contracts are very safe for the government.

Secondly, smart contracts could increase the low turnout. A large proportion of people do not vote because it simply takes up too much time and effort. With smart contracts, volunteers can hand over voting online and people can vote just that bit easier than before. Although this is not yet legally possible, there is a good chance that this will change in the future.

The medical world

Finally, it is possible that smart contracts will be used within the medical world. Personal health records could be encrypted and stored on the blockchain with a private key granting access only to specific individuals. The same strategy could be used to ensure that research is conducted in accordance with the appropriate privacy laws.

Receipts from operations could be stored on a blockchain and automatically sent to insurance companies as proof of delivery. The ledger could also be used for general healthcare management. Here one can think of improved monitoring of medicines or for the proper management of medicine stocks.

The benefits of smart contracts

The above should give you a better idea of what we mean by a smart contract. Based on the example, you understand exactly what it can be used for. What you do not yet know is what the main advantages of using smart contracts are. Although there are a number of other advantages, we have decided to list the most important ones for you below. These advantages are mainly on the technical side:

Smart contracts are fast and accurate

The main advantage of smart contracts is the fact that they are incredibly fast and accurate when applied. Smart contracts are digital and automated. As a result, you do not have to spend time processing paperwork or correcting the errors that often appear in manually completed documents. Computer code is also more precise than the legal jargon in which traditional contracts are written. This means that errors are less likely to occur or that there are ambiguities in the contract. This also means less time spent on dispute resolution in the long run, which is a big advantage for many companies.

Smart contracts offer a high degree of confidentiality

Another advantage of smart contracts is that they offer a high degree of confidentiality. Smart contracts automatically carry out transactions according to predetermined rules. The encrypted records of those transactions are then shared between the participants. This ensures that data cannot be changed just like that for personal gain. This high degree of confidentiality is particularly useful for companies entering into large contracts where a lot of money is involved.

Smart contracts are very safe to use

The next advantage is that smart contracts are very safe to use for businesses. The data on the blockchain is always encrypted. This makes them very difficult to hack. Because each individual record is connected to previous and next records on a distributed ledger, the whole chain would have to be changed to change a single record. This is actually impossible to do. Because of this high level of security, it is no longer possible for personal data to end up on the street. This can be a great advantage to, for example, hospitals that enter into agreements with their patients.

Smart contracts are cheaper

The final advantage of the smart contracts is that they are really a lot cheaper than regular contracts. As we have already briefly mentioned, smart contracts remove the need for intermediaries. With smart contracts, participants can trust that all data will be entered correctly for the transaction. No extra person is needed to validate and verify the terms of a contract because this is built into the code. This means that there are far fewer costs involved.

Although it does not make an extreme difference if you do not have to draw up so many contracts, it is of course true that companies can save money with this. Think, for example, of large-scale law firms that often have to deal with contracts they have to send out.

Cryptocurrencies with smart contracts

We hope that the information in this article makes it clear what smart contracts are and how they can be used. The unique technology behind the digital contracts ensures that less fraud will take place and that everything can be transmitted safely. If you are interested in projects that support smart contracts, there are numerous options to choose from. The most obvious option is to choose Ethereum. EOS and Chainlink, among others, also support smart contracts. Because of the numerous options, you too can invest in the technology behind smart contracts.

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Alex Mostert Avatar
Over Alex Mostert

When I was 16, I secretly bought my first stock. Since that ‘proud moment’ I have been managing for over 10 years. It is my goal to educate people about financial freedom. After my studies business administration and psychology, I decided to put all my time in developing this website. Since I love to travel, I work from all over the world. Click here to read more about! Don’t hesitate to leave a comment under this article.

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