Blockchain and NFTs

How Do Ethereum Smart Contracts Work?

In this article, we will discuss how smart contracts automatically execute transactions on the Ethereum blockchain without the need for an intermediary.

October 10, 2022

Smart contracts are collections of code that automatically execute transactions without a third-party middleman’s involvement. They are typically associated with Ethereum, a blockchain designed to accommodate smart contracts, but the idea isn’t restricted to any particular platform or network.

Nowadays intermediaries are everywhere in our digital lives. For example, even just sharing a cat photo with your friends online requires an intermediary like Facebook or Twitter—a central authority that sets and enforces the network’s rules. Smart contracts enable you to automate digital tasks without the need for central control.

In the case of conventional contracts, the terms between two parties are outlined in a document, which is enforceable by law. If Party A violates the terms, Party B can take Party A to court for not complying with the agreement. But a smart contract fortifies such agreements in code, and the rules are automatically enforced without the need of a third party.

Ethereum was created in 2013 specifically for creating smart contracts. It is also the world’s second-largest cryptocurrency by market cap. Smart contracts aren’t widely used outside of Ethereum, and Ethereum could eventually become the norm for executing and securing online relationships.

Hundreds of apps, for example, MakerDAO and Compound, use smart contracts at their core for lending and allowing users to earn interest. The idea of a “smart contract” was first conceived in 1993. Computer scientist and cryptographer Nick Szabo originally described it as a kind of digital vending machine where users could input $1, and receive an item, in this case, a snack or a soft drink.

In a simple example of an Ethereum smart contract, a user sends a friend 10 ether – the token native to Ethereum – but requires that it can’t be dispersed until after a certain date using a smart contract.

How Does a Smart Contract Work?

Generally, people consult a broker when they want to sell a house. The broker takes some percentage of the total amount to process the transaction and intermediate with the buyer and seller. So in the case of the smart contract, we eliminate the broker.

The whole process becomes cheaper and more secure in this way as the transaction takes place directly between two parties eliminating the middleman. This is programmed so that whenever an amount greater than a particular number is offered for the property, it will sell the house to the buyer, transfer the rights, and transfer the money to the seller.

Smart contracts are stored on the blockchain, and their two notable properties are immutability and global distributability. By saying immutable we mean once the smart contract is deployed, no one can tamper with it. And global distributability means everyone on the blockchain network validates the contract’s output. Users on the network may mark the contract invalid when someone tries to alter it, thus tampering is almost impossible.

Smart contracts can be programmed to work for the masses, replacing governmental mandates and retail systems potentially removing the need for bringing certain disagreements into court, saving parties both time and money.

Why Ethereum Smart Contracts?

Bitcoin is the world’s first cryptocurrency and the first to support basic smart contracts, although they are extremely limited in comparison with Ethereum. The network only accepts transactions if certain conditions are met – such as the user providing a digital signature showing that they hold the cryptocurrency they claim to own. Only a Bitcoin private key holder can produce such a digital signature.

Whereas, Ethereum replaces Bitcoin’s limited syntax, allowing developers to use the blockchain to process more than just cryptocurrency transactions. The language of Ethereum is “Turing-complete,” meaning it can perform a broader range of computations. Without limits, programmers can write just about any smart contract imaginable if there are no restrictions.

While this has obvious benefits, it also means that, because novel smart contracts are less tested increasing the likelihood of security flaws. Ethereum has already seen millions of dollars of losses from exploited vulnerabilities in smart contracts.

Benefits of Smart Contracts

Speed, efficiency, accuracy, trust, transparency, security, and savings are the various benefits of smart contracts.

Smart contracts save hours in various commercial processes by using computer protocols to automate actions. The automated agreements decrease the possibility of third-party manipulation by eliminating the requirement for brokers or other intermediaries to ratify the already signed legal contracts.

Moreover, the lack of an intermediary in smart contracts saves money. Also, all relevant parties have complete visibility and access to the terms and conditions of these contracts. So we may say that the transaction is entirely transparent to all parties involved, and there is no way to back out once the contract is signed.

In addition, all documents kept on the blockchain are duplicated many times, allowing for the restoration of originals in the event of data loss. Smart contracts also eliminate errors that occur due to manual filling out as they are encrypted, and cryptography protects all documents from being tampered with.

Conclusion

Many developers, researchers, and even attorneys and physicians are excited about the promises of smart contracts. However, it’s early days for smart contracts. While users of smart contracts do not have to rely on intermediaries, users must have faith in the code’s correctness, which is a massive question as there are still plenty of security issues. There have been discovered several bugs that enabled criminals to steal user money. The hope is these issues will become less common as the code evolves.

So, smart contracts are blockchain computer applications that carry out their tasks automatically. Tracking their transactions, predicting how they would behave, and even using them pseudonymously is possible. In the end, a smart contract is a computer program that can do almost any task another program can.