What Are Smart Contracts and How Do They Work?
There is hardly a time when technology is not reshaping the way we do business, the way we manage contracts, and the way we exchange value. Some of the most radical innovations of the blockchain era include smart contracts — self-executing digital contracts that automatically enforce terms without requiring any third-party intermediaries.
Smart contracts benefit a number of industries like finance, real estate, logistic, and healthcare since these guarantee security, clarity, and efficiency. So, what, then? Smart contracts and how do they work?
In this article, we will take a look at:
✔ What smart contracts are.
✔ How smart contracts work.
✔ Their main benefits and challenges.
✔ Practical use cases of smart contracts.
✔ Smart contract technology of the future.
What Are Smart Contracts?
a. What are smart contracts?
Smart contracts are self-executing programs that are stored on a blockchain and run automatically when predetermined conditions are met. It functions just like a regular contract but in the form of code that automatically performs actions without prompting anyone to execute them.
💡 Example : You can think of a vending machine. Inserting money and selecting a product will proceed with the automatic dispensing of the item. Smart contracts, for instance, work on a "if this happens, execute this" basis.
b. Who invented Smart Contracts?
Originating in 1994 from computer scientist Nick Szabo, the definition of smart contracts. But it was the explosive growth of blockchain platforms, such as Ethereum, which provide the infrastructure for smart contracts, that propelled them into the mainstream.
How Do Smart Contracts Work?
a. The Smart Contract Process
Smart contracts are based on blockchain technology and work in a very simple way:
1️⃣ Contract Creation – The agreed-upon terms by two or more parties.
2️⃣ Coding the Contract — The contract terms are encoded (programming languages like Solidiity for Ethereum are often used).
3️⃣ Deployment on Blockchain – The smart contract gets uploaded to a blockchain network.
4️⃣ Conditions executed — As previously established, the contract executes automatically once all conditions are met.
5️⃣ Transaction Finalization - After execution, the outcome gets logged as part of the blockchain, providing both transparency and security.
b. Technologies behind Smart Contracts
✔ Blockchain – An open, transparent and immutable digital record
✔ Cryptography – Ensures that transactions are secure and cannot be interfered with.
✔ Consensus Mechanisms — Blockchain networks use PoW or PoS to confirm the execution of smart contracts.
💡 For example: If a freelancer works through a smart contract, the payment will be automatically released to the freelancer upon work submission and approval without a third party.
Benefits of Smart Contracts
a. Automation and Speed
✔ Smart contracts automate transaction execution, removing the delays associated with manual processes.
✔ Less paperwork and admin pressure.
b. Security and Transparency
✔ Data on the blockchain is permanent, immutable, and tamper-proof.
✔ Transactions can be seen and verified by multiple parties, minimizing fraud risks.
c. Cost Savings
✔ Does away with intermediaries such as lawyers and banks, thus lowering transaction fees.
d. Trust and Reliability
✔ Smart contracts are exactly like programmed, ensuring fairness and no bias.
For example, smart contracts in the real estate could facilitate the transfer of a property on the payment made by the buyer eliminating the need for paperwork and less fraud risk.
Challenges of Smart Contracts
a. Coding Errors and Bugs
✔ If the smart contract is buggy, you can lose a fortune.
Example: $60 million Ethereum loss from 2016 DAO hack due to smart contract vulnerability.
b. Law and compliance issues
✔ Smart contracts are not yet legally applicable in many governments.
✔ It’s hard to enforce because regulations vary from country to country.
c. Scalability Issues
⚠️ Supported by Blockchain networks can go slow when many smart contracts are processed.
✔ For example: Ethereum gas fees → become more expensive with network congestion.
d. Lack of Flexibility
✔ Smart contracts are immutable once they are deployed.
✔ Bugs found in the contract need complicated solutions such as contract upgrades or forks.
🤖 Example: A contract that is coded wrong, users cannot challenge/update it and therefore you get unintended consequences.
Smart Contracts: Examples with Real Humanity
a. Finance and Banking
✔ Decentralized Finance (DeFi) – Smart contracts allow lending, borrowing, and trading without banks.
✔ Automating Payments – Payroll is automatically processed using smart contracts by companies.
✔ Ex: Aave & Uniswap- secure crypto transactions through smart contracts
b. Supply Chain Management
✔ Uses blockchain records to track goods from manufacture to delivery.
✔ Fraud prevention and logistics transparency
⚫ Example: Smart contracts for monitoring food supply chains by Walmart.
c. Real Estate
✔ Say goodbye to paperwork by managing contracts in digital format.
✔ And does so automatically with the transfer of property and payment.
✔ Eg: Propy is a blockchain-based company that lets consumers purchase real estate through smart contracts.
d. Healthcare
✔ Protects patient records so only authorized people may access them.
✔ Insurance claims and payments automation.
✔ Use case: Smart contracts to ensure accurate billing in healthcare.
e. IP & Ownership in the Digital Economy
✔ NFT (Non-Fungible Tokens) employs smart contracts to prove digital ownership.
➕ Artists and creator get automatic royalty payments for their work.
✔ Examples: OpenSea utilizes smart contracts to facilitate NFT transactions.
The Future of Smart Contracts
This means the new smart contracts need to quickly develop so we can enjoy new innovations.
a. Combined with future AI and IoT
✔ Automated decision-making with AI-powered smart contracts.
✔ The physical world will plug itself into smart contracts through IoT devices.
b. Cross-Chain Compatibility
✔ Multi-chain compatibility of smart contracts will provide enhanced flexibility.
c. Government & legal adoption
✔ Other countries will adopt smart contracts as legally binding contracts.
✔ Blockchain may be used by governments for public services and voting systems.
💡 P.S. The latest trend in signatures: smart contracts for government services! Case in point: Estonia.
Conclusion
By ensuring that agreements are secured, efficient, and transparent, smart contracts are changing the game of digital transactions. They cut out middlemen, lowering cost and accelerating processes across industries.
For this technology to become mainstream though, it must overcome the challenges of security risks, legal recognition, and scalability.
The future of smart contracts The future of smart contracts is promising, as the technology behind blockchain continues to advance, with potential use cases in finance, real estate, healthcare, and beyond. As developments continue, smart contracts might soon be a standard for digital transactions, revolutionizing the landscape of decentralized economies.