Blockchain technology has captivated many industries. The use of blockchain technology in business firms has resulted in the improvement of performance and overall growth. Integrating smart contracts into the blockchain network has helped in the automation of transactions without compromising security and transparency.
Key takeaways
- Smart contracts are digital codes that automate transactions when predetermined conditions are met.
- The codes in smart contracts are transparent and immutable.
- Application of smart contracts is seen in healthcare, supply chain, digital tokens, NFTs, and Insurance.
- Types of smart contracts include smart legal contracts, decentralized autonomous organizations, and application logic contracts.
What are smart contracts?
Smart contracts are digital codes that are directly written to a blockchain and get executed automatically when predetermined conditions are met. It automates the transactions without the need for an intermediary. Once a transaction is automated using smart contracts it can’t be undone or changed.
The idea of smart contracts was first proposed by an American scientist, Nick Szabo, the inventor of the virtual currency ‘Bit Gold’. The main aim behind designing a smart contract is to eliminate the involvement of a third party and make a one-on-one transaction possible. A real-time example of smart contracts is the vending machine when a user inserts money for a product and presses the button, the system analyses the conditions and releases the product out of the machine within seconds.
How does a smart contract work?
Smart contracts are programming codes that check for the validation of statements before processing the transactions. It can be used to send notifications, vehicle registration, release funds, or issue tickets. Once the predetermined conditions are satisfied, the blockchain processes the transaction and updates when the transaction is completed. The completed transactions can’t be changed and only the transaction parties can see the end result.
The written codes determine who can access the transactions, at what time, etc. If any conditions are not validated the system denies the transactions. Not all blockchain network supports smart contracts. Ethereum, Avalanche, Base, and BNB chains are the most popular smart contract compatible blockchains.
Advantages of smart contracts
Speed: Smart contracts automate transactions when the required conditions are met. The lack of an intermediary and the absence of paperwork fastens the transactions.
Transparency: The code of a smart contract is available in the blockchain and can be viewed by anyone. This transparency of smart contracts helps in building trust in the platforms.
Security: Smart contracts offer robust security. Before integrating into the blockchain networks, smart contracts undergo auditing in which every line of code is checked and verified.
Immutability: Smart contracts run on pre-existing codes and the codes can’t be changed or modified. The processing and denial of transactions are determined by the compatibility of the requirements with the codes.
Use cases of Smart contracts
Digital tokens
Smart contracts are used in digital tokens that allow holders to gain ownership rights on existing blockchain networks. It also helps in segmenting the ownership so that multi-party investments can be made.
Decentralized Finance (Defi)
Defi includes applications that utilize smart contracts to recreate traditional financial firms as well as forming new financial primitives.
NFT
NFTs are digital assets that can be used by one person at a time. NFTs use smart contracts for minting and ownership rights. When an NFT is created the smart contract automatically considers the creator as the owner and transfers the token to a new owner when a sale is made.
Supply chain
Designing a smart contract for an end-to-end supply chain eliminates the need for continuous management and auditing. It validates the authenticity of products and ensures transparency. An effective smart contract reduces the chance of fraud in the supply chain.
Health care
Healthcare system stores large sets of patient information which are prone to attacks. Using a smart contract in health care eliminates the potential risks. It prevents the leaking of patient information. Only people having access to the patient’s private key can retrieve the patient’s data. By integrating smart contracts, clinical trials can be conducted seamlessly across the industry. By sharing data between institutions, the effectiveness of clinical trials increases which helps in the overall growth of the medical industry.
Insurance
Smart contracts automate policy management and help in detecting fraud. By automatically streamlining issuance and renewal of policies they reduce the administrative hurdles. Smart contract-aided underwriting helps in faster sanctioning of requests and also eliminates the possibility of risk.
Types of Smart Contracts
Smart contracts are classified into three: smart legal contracts, decentralized autonomous organizations, and application logic contracts.
1. Smart legal contracts
Legal contracts are more open to entities than traditional documents. A smart legal contract must abide by the conditions for sanctioning a transaction. Since smart contracts are endorsed in blockchain and are immutable they have to be verified carefully before execution. The transparency of smart contracts allows users to analyze the set conditions. Smart contracts are executed with digital signatures from involved parties.
2. Decentralised autonomous organizations
Decentralized autonomous organizations are democratic groups that are controlled by smart contracts for making informed decisions. The organization is not controlled by a president or executive but blockchain-based tenants determine the working of the organization and how the funds have to be distributed.
3. Application logic contracts
Application logic contracts consist of application-based contracts that are synced with many other blockchain contracts. These smart contracts are not signed between humans, instead they are signed between machines and other contracts. The machines can include IoT (Integration of Things) or blockchain integration.
Limitations of Smart Contracts
Immutability
Though immutability is an advantage, when an error occurs in the code it can’t be changed.
Chances of loopholes
Using a smart contract makes it difficult to analyze whether the code execution is made on the agreed conditions.
Human engagement
The codes of smart contracts are generated and audited by humans thus the chances of occurrence of an error can’t be neglected.
Third-party involvement
It is true that smart contracts eliminate the need for a third party, however, to understand the legal terms the involvement of an advocate will be necessary.
Unclear terms
Smart contracts can’t handle unclear terms always and the chances of occurring unclear terms are common.
Conclusion
Smart contracts are an integral part of a blockchain system. It’s not necessary that every blockchain must hold a smart contract, but integration helps. Smart contracts process the transactions without the involvement of a third party. It ensures security and transparency within the blockchain network. However, a code error can lead to serious risks including the occurrence of fraud. The chances of re-allocation of codes by hackers can also not be neglected.
Also Read: What Is Blockchain Technology? Explained!