Smart Contracts Explained

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After the rise of the Ethereum platform, smart contracts have emerged as a game-changer in the future of Decentralized Finance (DeFi).  So what makes smart contracts so smart? Aside from the customisability and the digital signatures attached, smart contracts are smart because of their self-executing nature.

In this handy guide, Liquid has explained some of the basics you want to know about smart contracts and how it works.

What Are Smart Contracts?

Smart contract is a term used to describe computer code that automatically executes all or parts of an agreement and is stored on a blockchain-based platform. 

The smart contract refers to a computer program that takes place on a blockchain or distributed ledger technology. Since it does not involve any third-party for verification of the agreement, a corresponding blockchain network can verify transactions based on conditions specified in smart contracts.

You can compare smart contracts to a digital vending machine where the device itself dispenses the item following the item selection and payment completion by the user, without the need for an intermediary. Smart Contracts bring the same concept to Decentralized Finance (DeFi), which aims to remove intermediaries from the equation and creates secure and credible financial transactions.

Developers can create a smart contract to verify a transaction between two parties without intermediaries. For example, Joe likes to buy a house from Ben. They can rely on a smart contract to transfer the house ownership only after the payment has been made as per the terms and agreement.

Similarly, Smart contracts can be used for various purposes, such as transferring sensitive information, including patents, copyright claims, supply chain, and even voting.

How Do Smart Contracts Work?

Smart contracts can take place on various blockchain networks including Ethereum. However, there are three significant steps in the functioning of smart contracts.

  1. The developer creates a decentralized application (DApp). These applications have smart contracts running on a decentralized blockchain network.
  2. Once smart contracts go live on the blockchain, none of the parties can make changes to them. A blockchain network will then process and finalize the transaction after all of the conditions specified in the smart contract have been met. 
  3. The blockchain network ensures both ends of the agreement are verified without any third party.

How Can Smart Contracts Benefit the Crypto Ecosystem?

The primary objective behind smart contracts is to eliminate the need for intermediaries from the transactions. As a result, customers are not required to pay commissions to a third party or suffer delays due to human errors like miscalculation and logistics management.

Once the blockchain takes over, it can automate the multiple sectors involved (say, payment, approval, and confirmation) and offer convenient transactions to customers.

Smart contracts are also considered to be more accurate than traditional means. They can be used to transfer assets from one party to another. Interestingly, the trust factor is seamlessly taken care of by the blockchain network in intermediaries’ absence.

Smart contracts are also highly customizable. The developer has enormous control over how a smart contract works. That is essentially why Initial Coin Offerings (ICOs) and DApps rely heavily on smart contracts.

Security of Smart Contracts

No single party has ultimate control over a smart contract. It is essential in ensuring the credibility of the transactions done through the smart contract. It also reduces the chances of fraud to a minimum.

Once it goes live on the blockchain network, a smart contract is handled and verified by different nodes of the blockchain network. That is presumably why smart contracts are considered to be highly secure.

If an attacker wants to modify a smart contract, they will have to modify all the corresponding nodes of the blockchain network, which is a near-to-impossible task.

This way, smart contracts can also help the crypto ecosystem become autonomous and trustworthy.

Shortcomings of Smart Contracts

Even though smart contracts aim to remove intermediaries from transactions, it does not mean they are free from software bugs affecting the execution of the function. It can be a significant issue depending on the nature and sensitivity of a particular smart contract.

The Future of Smart Contracts

While smart contracts can make the crypto ecosystem a better space, they have a long way to go. 

The smart contract technology is not as perfect as it seems to be at first sight. There can be some bugs and errors in the code that should be checked and eliminated. However, smart contracts tend to be a terrific technology in the sense of how people and organisations can interact with each other. 

Blockchain became that environment where smart contracts can be executed in the correct way. The technology needs such additional features as oracles to improve smart contracts and make them accessible for parties to interact without any middlemen.

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