What are Smart Contracts and How they Relate to Blockchain?

What are Smart Contracts and How they Relate to Blockchain?

in Cryptocurrency

A smart contract is blockchain-based digital contracts which contain the rules that the parties set and under which they are agreed.

The mechanism of the smart contracts involves the digital assets use. The assets are redistributed according to the formula that the parties set initially.

blockchain smart contracts

Smart contracts history

In 1994 Nick Szabo proposed the idea of smart contracts. Nick Szabo, known as a cryptographer and a legal scholar, formed the basis for the cryptocurrency. However, at that time there was not any interest in smart contracts because of the digital platforms absence.

In 2008 Satoshi Nakamoto, using the cryptographic development in the blockchain area created Bitcoin. This technology enabled the smart contracts code working out and implementation.

smart contracts history

Why Blockchain?

Why did the smart contracts code wait for the Bitcoin creation? The thing is that when people started using the digital currency technology the basis of the cryptocurrencies — blockchain — received a significant boost as well. As you can understand Blockchain is not only the crypto coins base. It is also used in other scientific areas.

The idea of an uncorrupted digital system impressed the smart contracts developers. Blockchain guarantees that the users' information recorded on a distributed ledger is securely stored and is protected from loss or an external impact. These conditions are ideal for making business, providing money transactions, storing data, protecting ownership and whatever else.

You can read more about blockchain in our guide.


How it works

The simplest analogy of the smart contracts mechanism is the work of a vending machine. The machine is programmed to make certain actions in particular circumstances. You press a number of a product in the menu and make a deposit. The machine checks the sum of money you deposited and gives you the product you selected if the amount of money is enough. If you put too much money the machine gives you the change. If vice versa, you put too little sum, the machine brings your money back without the product. The same the smart contracts do.

how smart contracts work

Let's consider the other example. Bob is going to sell Alice a car. The deal is simple and depending on the country needs the involvement of, at least, one middleman in the face of an insurance company, a lawyer or someone else — it does not matter here. In a word, a third party.

Here is how it would look like if the deal took place with the smart contracts help: Bob defines in the smart contracts system the terms of the sale, publishes the public key and sigs the terms with his private key. He leaves his car in the garage with a smart lock protection. The smart lock is under the smart contracts control.

Alice is looking through the car sale advertisements on the Internet and finds Bob's one. She agrees with Bob's terms and sends crypto coins from her cryptocurrency walletto the public address Bob has left in the advert.

The smart contracts vending machine function starts working. Each node in the blockchain verifies Alice's transaction while the smart contract checks if Bob is indeed the owner and if Alice has sent enough money for the car. If all the conditions comply and the blockchain network verifies the fact, Alice gets an access code to the smart lock of the garage. The smart contracts register that Alice is a new owner of the car and anyone in the network can confirm that looking at Alice's transaction in the blockchain.

smart contracts example

Let's take a more complicated example. You have a company that manufactures and sell cars. To make all the operations related to the raw material acquisition, shipping both the raw material and finished products, selling and tracking the production you need a lot of staff. However, you will minimize its number if you have the same suppliers and a standard procedure for all the other operations the smart contracts can automate the process taking control under the raw material acquisition and tracking the products. If there are any problems the company can check the blockchain records and find out what is wrong or track the location of a product.

smart contracts auto

Here is an encoded example of the smart contracts:

smart contracts code

Smart Contracts benefits

smart contracts benefits

Smart contracts provide:

  • Reliability — no one can lose, change or delete your documents as they are stored and encrypted in a distributed ledger
  • Speed — all the processes are automated in the blockchain, so you don't have to lose time on the manual documents processing
  • Security — as the documents are encrypted, no one can get access to them without a private key
  • Money accumulation — you don't have to pay a third party for his services nor to hire a staff to monitor the goods
  • Independence — no third parties are in need
  • Cover — even if you lose your documents on your device you can get access to them in the blockchain using your private key and another device
  • Accuracy — lack of the manual filling mistakes

Smart Contracts drawbacks

Smart Contracts drawbacks

  • No regulation — there are no any regulation rules relating cryptocurrency, blockchain or smart contracts so there are no courts where you could appeal the decision.
  • Difficult to implement — if you have made a smart contract but the circumstances have changed you cannot make changes in the smart contract without creating a new one.

Who can use smart contracts?

  • Businesses

Jeff Garzik, co-founder of blockchain services startup Bloq said about the smart contracts:

“UPS can execute contracts that say, ‘If I receive cash on delivery at this location in a developing, emerging market, then this other [product], many, many links up the supply chain, will trigger a supplier creating a new item since the existing item was just delivered in that developing market.’ All too often, supply chains are hampered by paper-based systems, where forms have to pass through numerous channels for approval, which increases exposure to losing and fraud. The blockchain nullifies this by providing a secure, accessible digital version to all parties on the chain and automates tasks and payment."

  • Automobile industry

There are a lot of perspectives for the industry in the future. Smart contracts can control the traffic, find out who is guilty in a car crash, or become a basis for the autonomous vehicles.

  • Insurance

The insurance agencies every day get millions of claims including fraud ones, from people who are waiting for the reimbursements. The smart contracts could cut the fraud and fulfill the claims which don't need a personal involvement. For example, the compensation for the canceled flights.

insurance smart contracts

  • Real Estate business

Usually to rent an apartment you have to contact to such middlemen like an advertising agency, brokers, real estate agents, money lenders and so on who takes their fees for the deal. With the smart contracts, you just encode the contract and accomplish automatic fulfillment.

  • Governments

Smart contracts can be implemented in the government's voting system and provide a transparent voting process in such a way that no one can interfere because no one has the similar computing power.

government smart contracts

  • Healthcare

All of us have medical data in the hospital that could be encoded and stored in the blockchain with limited individuals who can access the information. Besides, the smart contracts can be useful for drugs supervising, testing results, managing medical supplies etc.

  • Management companies

Smart contracts provide an automated accurate system without any delays.

smart contracts in use



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