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What Is a Smart Contract? How Does It Work

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Key Takeaways

  • Smart Contracts?
  • How Smart Contracts Work
  • Benefits of smart contracts
  • Smart contract platforms

In recent years, the rapid development of blockchain technology and cryptocurrencies has influenced the financial industry and created a new crypto economy.

Thanks to the emergence of smart contracts, which are computer protocols, next-generation decentralized applications have emerged without the need for a trusted third party to automatically facilitate, review, and enforce negotiations and agreements between multiple untrustworthy parties. Despite the positive side of smart contracts, several concerns continue to undermine their adoption, such as B. Security Threats, Vulnerabilities, and Legal Issues.

For more than a decade, blockchain has been established as a technology in which a distributed database records all transactions that have taken place in a peer-to-peer network. It is viewed as a distributed computing paradigm that successfully overcomes the trust problem.

Therefore, in a blockchain network, multiple nodes work together to secure and manage a set of shared transaction records in a distributed manner without relying on a trusted party. In 2008, Satoshi Nakamoto introduced Bitcoin [69], the first proposed cryptocurrency that introduced blockchain as a distributed infrastructure technology. Users were able to securely transfer cryptocurrencies, so-called “bitcoins”, without a central regulatory authority.

In addition, Ethereum [16], NET [71], and Hyperledger Fabric [4] were proposed as blockchain-based systems for cryptocurrency. Unlike Bitcoin, they can use Smart Contracts (SC). Blockchain technology overlaps traditional Ts contracts by containing the contractual terms between two or more parties but surpasses them by

automating the execution of contracts thanks to smart contracts. Agreements in a distributed environment when the conditions are met.

Smart Contracts?

Smart contracts & executable code Explained Image
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Smart contracts are executable code that runs over the blockchain to facilitate, execute, and enforce an agreement between untrustworthy parties without the involvement of a trusted third party. Clarifying this Statement more A smart contract is a computer protocol designed to digitally facilitate, review, or enforce the negotiation or execution of a contract.

Smart contracts enable credible transactions to be carried out without a third party. One of the best things about blockchain is that it is a contract, a decentralized system that exists between all approved parties. There is no need to pay intermediaries (intermediaries) and it saves you time and conflict.

How Smart Contracts Work

The terms of the contract are written in code. The smart contract runs on the decentralized blockchain platform Ethereum. The agreements facilitate the exchange of money, stocks, property, or assets. There are two widely used programming languages ​​for writing Ethereum. Smart Contracts: Solidity and Serpent, Solidity is a high-level programming language used to implement Smart Contracts on the Ethereum blockchain platform. Blockchain developers can review the program at runtime instead of at compile time. 

Traditionally, when two parties enter into a contract, they use the services of a trusted third party to execute the agreement. It has been doing this way for centuries. However, the introduction of smart contracts and related technologies automate what was previously a tedious manual process

How Smart Contracts Work Explained Image
Unsplash image by Shubham Dhage

Smart contracts were first proposed in 1994 by Nick Slabs, an American computer scientist, who invented a virtual currency called “Bit Gold” in 1998, 10 years before Bitcoin was invented. In fact, it is often rumored that Stab is the real Satoshi Nakamoto. , the anonymous inventor of Bitcoin who has denied. Slab defined smart contracts as computerized transaction logs that execute the terms of the contract.

He wanted to expand the functionality of electronic transaction methods such as POS (Point of Sale) to include this. In his work, Slab also proposed the execution of a contract for synthetic assets such as derivatives and bonds. Stab wrote: “These new securities are formed by combining securities (such as bonds) and derivatives (options and futures) in a variety of ways. 

Very complex maturity structures for payments can now be integrated into standardized contracts and traded with low transaction costs due to the computer-aided analysis of these complex conceptual structures, Slabs’ predictions have come true in his work in a way that predated blockchain technology. For example, derivatives trading today is mainly carried out via computer science networks using complex conceptual structures.

In 2008, Satoshi Nakamoto introduced Bitcoin, the first proposed cryptocurrency that introduced blockchain as a distributed infrastructure technology. It allowed users to securely transfer cryptocurrencies known as “bitcoins” without a central regulator. In addition, Ethereum, NXT [], and Hyperledger Fabric were proposed as blockchain-based systems for cryptocurrency.

Unlike Bitcoin, they can use Smart Contracts (SC). Blockchain technology overlaps traditional contracts by containing the contractual terms between two or more parties, but thanks to smart contracts it overcomes it by automating the execution of agreements in a distributed environment when conditions are met.

Satoshi Nakamoto introduced Bitcoin Explained Image
pixabay image by Tumisu

Smart contracts are executable code that runs on top of the blockchain to facilitate, execute, and enforce an agreement between untrustworthy parties without the involvement of a trusted third party [16].

Smart contracts enabled network automation and the ability to turn paper for action into digital contracts. Compared to traditional contracts, smart contracts enabled users to encrypt their agreements and trust relationships by providing automated transactions without the supervision of central authority [89].

 To avoid changing the contract, smart contracts are copied to every node of the blockchain network. By allowing operations to be performed by computers and services provided by blockchain platforms, human error could be reduced to avoid disputes regarding such contracts.

Although smart contracts have made strides in recent years, they still face many challenges. For example, a notorious malicious attack took place in 2016 when the Decentralized Autonomous Organization (DAO) smart contract was tampered with to steal around 2 million Ether Footnote1 ($50 million).

 At the time due to its susceptibility to re-entry. In addition to the problem of vulnerability, smart contracts face various challenges including privacy, legal, and performance issues.

In this article, you will learn about the technology behind smart contracts and how they can be used. First, let’s understand some key advantages of smart contracts over traditional contracts:

Smart contracts work by following simple “if / when … then …” instructions written in code on a blockchain. A computer network takes action when predetermined conditions are met and checked. These measures could include the release of funds to the appropriate parties. , register a

vehicle, send notifications or issue a ticket. The blockchain will be updated when the transaction is complete. This means that the transaction cannot be modified and only the parties that have been given permission can see the results.

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Unsplash image by Marija Zaric

  There can be as many determinations as necessary to convince participants that the task will be completed successfully. In order to set the conditions, the participants must determine how transactions and their data are represented in the blockchain, agree on the “if / when … Then …” rules that govern these transactions, investigate all possible exceptions,

and define a framework for settling disputes The smart contract can then be programmed by a developer. However, companies using blockchain for businesses are increasingly making templates, web interfaces, and other online tools available to make it easier to structure smart contracts.

Benefits of smart contracts

Speed, efficiency, and accuracy

Once a condition is met, the contract is executed immediately. Because intelligent contracts are digital and automated, there is no need to process documents and spend time reconciling errors that are often caused by manually filling out documents.

A large number of brokers and middle shifts involved in the execution of a traditional contract slows the process and often takes days or even weeks. Smart contracts can only take a few minutes because they are automated, programmable, and run on a computer under normal conditions. Predefined. There are no third parties involved.

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Accuracy, Trust, and Transparency

Since no third party is involved and encrypted transaction records are shared between the participants, there is no question of whether the information has been changed for personal gain. The general terms and conditions are predefined and integrated into a smart contract. As soon as a condition is met, the transmission is automatic and recorded.

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Unsplash image by Savvas Stavrinos

When a referral is linked to a traditional contract, it is a manual process that includes approval workflows. It is dictated by the parties, peripheral units, and intermediaries involved. It’s an imperfect system.

However, smart contracts are 100% transparent and available online 24 hours a day, 7 days a week, and 365 days a year. Anyone can review, review, and validate archived transactions. Difficult with traditional contracts as they are paper-based and kept offline. Tracking transactions is cumbersome. Transactions in smart contracts can be tracked from the origin, and the archive is created automatically, creating a fully accessible history.


Smart Contract Security Explained Image
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The blockchain transaction records are encrypted which makes it very difficult to hack. Since each record is linked to the before and after records in a distributed ledger, hackers would have to change the entire chain to change a single record. Privacy and security are concerns with traditional contracts. With so many intermediaries involved, security can be compromised at any stage of the process.

When using smart contracts, security is ensured through cryptography, public and private keys. Data that is managed in a decentralized system can hardly be changed. Smart contracts are digitally signed using private keys and can only be decoded using the public key that the parties involved share.


Intelligent contracts eliminate the need for intermediaries to process transactions and thus also for the delays and fees associated with them. Traditional contracts are expensive compared to smart contracts simply because all of these intermediaries have to be paid. Smart contracts have no intermediaries and the only transaction fees come from the underlying infrastructure of the blockchain network that executes the smart contract.

Operating process for smart contracts

A smart contract is a joint agreement between two or more parties. Saves the information, processes inputs, and writes outputs thanks to its predefined functions [16]. For example, the smart contract can define the constructor function that activates the smart contract.

The creation of a new smart contract in the blockchain is made possible by calling the constructor function via a transaction whose sender becomes the owner of the smart contract. A self-destruct function is another example of the functions that can be defined in a smart contract. 

Operating process for smart contracts describe image
Unsplash image by @new_data_services_oldb

Only the owner of the smart contract can destroy the contract by calling this function. A smart contract is likely to be a class that contains status variables, functions, function modifiers, events, and structures [16] that are used to execute and control relevant events and actions in accordance with the terms of the contract.

You can also call other smart contracts. Every smart contract contains states and functions. Some data or the owner’s wallet address (ex., the address where the smart contract is implemented).

We can distinguish between two types of states, namely constant states that can never be changed and writable states that store states in the blockchain. Or change states we can distinguish between two types of functions, read-only functions that do not require footnote2 gas to execute and write functions that require gas, as state transitions have to be encoded in a new block of the blockchain.

The currency is required to prevent the execution of infinitely smart contracts. As mentioned above, a smart contract is hosted on the blockchain by calling its constructor function through a transaction sent to the blockchain network.

Then the function of the constructor is carried out and the final code of the smart contract is stored in the blockchain. After the implementation, the Smart Contract Creator received the returned parameters (e.g. the contract address). Then users can invoke any contract function by submitting a transaction.

Smart contract platforms

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Smart contracts can be developed and implemented on various blockchain platforms (e.g. NET, Ethereum, and Hyperledger Fabric). Different platforms offer different capabilities for developing smart contracts, including contract programming languages, contract code execution, and security levels. 

Some platforms support high-level programming languages to develop smart contracts. Here we discuss some main platforms which deal with smart contracts…

Bitcoin is a public blockchain platform that can be used to process cryptocurrency transactions but has very limited computing power. Bitcoin uses a stack-based byte code scripting language. The language is very limited. Substantial changes to both mining functions and mining incentive systems would be required to enable proper smart contracts on the Bitcoin blockchain.

NET is an open-source blockchain platform based entirely on a proof-of-stake consensus protocol. Contains a selection of smart contracts that are currently active; However, it is not Turing-complete, which means that only existing templates can be used. And a custom smart contract cannot be implemented.

NFT Explained Image
pixabay image by TheDigitalArtist

Ethereum is the first blockchain platform to develop smart contracts. It supports advanced and custom smart contracts using a full Turing virtual machine called the Ethereum Virtual Machine (EVM). EVM is the environment. Smart contract execution process and every node on the Ethereum network is running an EVM implementation and executing the same instructions.

Robustness is a high-level programming language is used to write smart contracts and the contract code is compiled into EVM byte code. Ethereum is currently the most popular smart contract development platform and can be used to design different types of decentralized applications (Apps) in different domains. 

Instead of the public blockchain like Bitcoin and Ethereum where any party can join the network, Hyperledger Fabric is allowed and only a collection of business-related organizations can join through a member service provider.

and their network is built from the peers who belong to and are contributed by these organizations. Hyperledger Fabric is an open-source enterprise distributed ledger technology platform proposed by IBM and compatible with smart contracts. It offers modularity and versatility for a wide range of industrial use cases. The modular architecture for Hyperledger Fabric accommodates a wide variety of business use cases through plug-and-play components.

Smart contracts from Ethereum and Hyperledger Fabric differ in several ways. While Solidity is the well-known programming language for writing Ethereum smart contracts, Hyperledger Fabric supports smart contracts in multiple languages ​​such as Go, Java, and JavaScript.

In code execution, the contract code in Ethereum is contained in a transaction that is passed on in the peer-to-peer network, and every miner who receives this transaction can execute it on his local virtual machine. When the application creates a transaction in Hyperledger Fabric, only specified pairs (supporting pairs) execute and sign the transaction. Upon receipt of the transaction proposal

from the application, each of these supporting pairs independently executes it by calling the chain code to which the transaction relates. For security reasons, the chain code for isolation is executed in an environmental container (e.g. Docker). These blockchain-based development platforms are used in the existing studies, which I explain in detail in the following sections.

Using blockchain in the voting process can eliminate common problems. A central voting system has difficulties tracking votes: identity fraud, wrong counts, or prejudice from voting officials.

When using a smart contract, certain pre-defined conditions are preset. No voter can vote on a digital identity other than his own. Counting is very easy. Every vote is recorded on a blockchain network, and the count is automatically counted with no third-party intervention or reliance on a manual. Each ID is assigned to a single voice.

 The validation is carried out by users in the blockchain network themselves. Therefore, the voting process can take place in a public blockchain or in a decentralized autonomous blockchain facility based on an organization. As a result, every reconciliation is recorded in the general ledger and the information cannot be changed.

This ledger is publicly available for review and review. With smart contracts, you can create voting systems in which you can add and remove members, change voting rules, change discussion periods, or change majority rules. For example, you can create a vote for a decision within a decentralized autonomous organization. Instead of a central authority making a decision, a voting mechanism within the organization can determine whether the proposal is accepted or rejected.

Smart contracts based on Ethereum can be used to create digital tokens for transactions. You can design and spend your own digital currency and create a negotiable computerized token. Tokens use a standard currency API.

In the case of Ethereum, there is ERC 2.0 standardization. Allow the contract to automatically access any wallet for exchange. As a result, you create a tradable token with a fixed offer. The platform becomes a kind of central bank that issues digital money. For example, let’s say you want to start a business that requires funding.

ERC-20 Token Explained Image
Source: CoinWist

But who would lend money to someone you don’t know or who you don’t trust? Smart contracts play an important role. Ethereum allows you to create a smart contract to hold tax money until a certain date has passed, or a goal is met. Depending on the outcome, the funds will be passed on to the contract holders or returned to the contributors.

Lots of problems with management systems. To counteract this, a DSO (Decentralized Autonomous Organization) is used for crowdfunding. The terms and conditions are set out in the contract, and each person who participates in the crowdfunding is given a token. Every contribution is registered in the blockchain.

Smart contracts have proven to be a promising new solution for developing completely decentralized applications without the involvement of a trusted third party. Despite the positive side of smart contracts, several concerns continue to undermine their adoption, namely performance issues, security threats, and privacy issues. The new intelligent contract applications are more demanding in terms of contract execution time, execution costs, security, and data protection.

End of the Story

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