What is a smart contract, and how it works?
In the blockchain industry, smart contracts make transactions secure, automatic, and fast. They are usually associated with blockchain, but smart contract technology predates Bitcoin and blockchain. Let's explore together what is a smart contract.
Smart Contracts: What They Are
Nick Szabo first proposed the idea of smart contracts in the nineties. According to him, smart contracts are data-transfer protocols that use special algorithms to execute the transfer and track the transaction terms.
We can define a smart contract this way. It is a code in a blockchain that tracks the algorithm for all predetermined conditions. All the information stored in the code is necessary for the transaction. It is signed by the parties to the transaction. Due to this, the contract is executed automatically.
The smart contract is created in the blockchain. This means that the contract conditions are stored in a distributed database. They cannot be changed without others knowing about it.
For a transaction to be executed, the system must have some data:
- Participants. They are verified with electronic signatures.
- The subject of the contract. These are goods, services, digital assets, information, etc.
- The terms of the contract. These are the data that contain the obligations of all participants. They are fulfilled for the smart contract to be completed.
How does a smart contract work?
Here is an example. Suppose a company orders 10 tons of wheat from a farm. The company fixes the means of payment in the contract. It will be approved after the farmer delivers 10 tons of wheat. The funds are released once the delivery goes through and the farm receives the funds. The contract is fulfilled by both parties.
But, if the goods are not delivered on time, or the wheat arrives in smaller quantities, the contract can be terminated. The contract terms are spelled out in advance, so they all need to be fulfilled by all parties to the transaction.
In general, this is how smart contracts work for certain transactions and operations. Only the subject for exchange are tokens and cryptocurrencies, and the terms are the actions with these assets.
What are smart contracts for?
As mentioned earlier, smart contracts can be used to trade various assets, from real estate to stocks. Smart contracts are needed to eliminate intermediaries and reduce the costs of trade transactions and operations between individuals and businesses. In general, smart contracts are needed to fundamentally improve business, to make it transparent, secure, and traceable.
That is why this technology has become very popular in cryptocurrencies. A smart contract allows you to create a relationship between the parties, and you do not have to provide personal information. The terms of anonymity are preserved, and the parties honestly comply with the prescribed rules.
Where smart contracts are currently used?
Smart contracts are now being used in various areas of the economy. Let's look at some of them.
Smart contracts are used for digital identity on the web or social networks in banking structures. They are also used in real estate, allowing transactions to be made securely without the involvement of realtors and real estate agencies.
They are also used in the insurance industry, allowing the creation of an insurance policy that will be honored when conditions are met. Increasingly, smart contracts are being used in logistics. Companies involved in supplying goods to global markets are using smart contracts to ensure that deliveries are made without delays, and payment is instantaneous.
In addition, smart contracts are used in the medical industry, in elections, and in electronic voting. Thus, the range of use of smart contracts is getting broader and wider.
As smart contracts become more prevalent in the economy, it is imperative that they are secure. Recently, more and more cases have been recorded where smart contracts are hacked and customer funds are lost. Therefore, smart contracts should be checked for security.
Principles of smart contract security
An audit must be performed to confirm the security of a smart contract. Through auditing, the contract code is examined. Audits are either conducted by the projects' developers with smart contracts themselves or by third-party companies specializing in these issues. In particular, audits are conducted by the well-known company Certik.
First, a preliminary audit of the smart contract is carried out. The result in a report is forwarded to the developers if it is audited by a third-party contractor. Next, amendments are made to secure the smart contract if problems are found. After all, procedures are completed, the smart contract is submitted in a new form with no vulnerabilities.
If audits are not done or are rarely done, there is a high likelihood of a smart contract being hacked by attackers and losing funds.
In summary, smart contracts are effective tools for conducting business. They are used in a wide variety of areas of today's economy. At the same time, they are subject to certain vulnerabilities. To eliminate them, audits are conducted. Thanks to them, smart contracts also become safe for transactions between all participants. Currently, almost any user can create a smart contract and run it on the network.