Smart contracts are everywhere, and yet they are still often misunderstood. Many people don’t know how these contracts are created or applied, which can lead to mistrust and or even fear. Because they are growing in popularity daily, it is important to have a clear understanding of what these contracts are and how they work.

What Are Smart Contracts?

Smart contracts work in much the same way any other contract: they set the rules or guidelines for a given transaction and help people to make exchanges of goods and services in a commonly agreed-upon manner. They establish order in the process.

The main difference between a regular contract and a smart contract lies in the execution of these exchanges. Smart contracts automate transactions between parties. They employ special algorithms that allow people to exchange goods and services digitally without the need for third-party services such as brokers, agents or notaries. This offers an excellent advantage for people who value autonomy.

In addition, rather than relying on traditional means of exchange, smart contracts make use of cryptocurrency, which is decentralized — meaning companies or governments cannot produce new units. A software program is used to collect the currency that is being exchanged.

Can Smart Contracts be trusted?

In many cases, people are uneasy with the idea of exchanging currency online. Even established companies that have been in business for years have experienced security breaches that leak customer information. This adds to people’s wariness when considering smart contracts or cryptocurrency. However, this fear can be allayed over time with continued exposure to the idea and a better understanding of its place and purpose.

How Do Smart Contracts Work in Blockchain?

A blockchain is a list of records. These records, once recorded, are permanent and cannot be changed. This makes them a safe and reliable way to create transactions between two parties. These blocks are managed by a peer-to-peer network that holds to a specific protocol for validating new blocks.

The consistent and reliable nature of blockchains makes them the ideal platform for the use of smart contracts. Smart contracts can be encoded onto any blockchain.

You can create a contract that distributes funds to an individual once they have completed a task you employed them to complete. This is an extremely efficient and reliable way to conduct transactions, as it eliminates many of the errors involved with traditional exchanges. The application for this type of contract is growing and expanding quickly. The implications are not yet fully understood, but the potential is vast.

Even with the secure nature of smart contracts, concerns and potential problems exist. After all, no system is perfect. It is important to identify some of the leading concerns with this type of transaction. For instance, we know that once the contract is completed, it is very secure. However, during the process of completion, there are certain risks, e.g.:

  • Information leaked to parties outside of the transaction.
  • Hackers able to access and change the code used to write the smart contract, thereby changing the outcome.
How smart contracts work
Source: slideshare.com

While these are real issues that could arise, this system is as secure — and perhaps even more secure — than other types of exchanges. There will always be risks, but these are worth taking.

Where Can Smart Contracts Be Applied?

Smart contracts can be used anywhere. The consistent and reliable nature of these contracts has proven to increase the trust of the end user. This is especially useful in the expansion of free markets across various locations and cultures. Some people might be hesitant to enter into transactions with people outside of their geographical areas due to various laws and forms of government that regulate traditional currency. Using smart contracts and cryptocurrency can eliminate these concerns. Because traditional contracts hinge on trusting the other party, there can be some hesitation. The secure nature of cryptocurrency eliminates this concern and opens the markets to a greater number of people around the world.

The largest obstacle currently facing the expanded use of smart contracts and cryptocurrency is education. Once people understand the secure nature of this method, they will learn to embrace it further. You don’t have to be a programmer to use smart contracts. In fact, many people have already used them perhaps without even knowing the term. A common way of explaining this type of transaction to people is the vending machine example

EXAMPLE  

Smart contracts are similar to the self-executing contract that consumers participate in when they place their money in a vending machine. They select a product at an agreed-upon price, and once the funds are deposited, the product is released.

 

This is the same way a smart contract works. Once people understand them, smart contracts will continue to grow in popularity and become more established and mainstream.

How can smart contracts be used
Although smart contracts are still primarily used in the exchange of goods and services, they are not limited to this situation. They can be used for everything from crowdfunding to auctions to multi-signature wallets. Some have even suggested using them for voting — however, this will probably always be up for debate because, as we have seen, no system is completely secure. Voter fraud can occur in many different ways. It would take a great deal of time to educate the public, but perhaps it may be accepted in the future.

How to develop smart contract solutions based on blockchain?

For now, it seems, these smart contracts are actually best used to employ simple agreed-upon transactions between parties who are willing to trust the security and anonymity that these contracts provide.

Watch how Ciklum R&D Team implements blockchain IoT demo based on the Ethereum smart contract:


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