Earlier referred to as self-executing contracts, blockchain contracts, or digital contracts, a smart contract is a powerful neutralizer in contract law and the fintech space.
A smart contract is a powerful type of code that runs on the blockchain network. In its simplest form, a smart contract can minimize the risk associated with financial transactions and virtually eliminate conflict and wasted time associated with the exchanging of assets.
While this concept is not necessarily new (the term was coined in 1994), smart contract development is still evolving. Smart contracts are powerful tools to be used in completing a transaction, settling agreements, and for use in blockchain applications.
To help you better understand how a smart contract works, this article will go over:
- What smart contracts are used for
- How smart contracts work
- How to develop a smart contract
- How to use a smart contract
What Smart Contracts Are Used For
A smart contract operates as a piece of code or computer protocol that can digitally verify and enforce the workings of a contract or agreement. A smart contract eliminates the need for an intermediary and can be used in automatically mitigating agreements between parties.
Things like money, property, shares, or services can be agreed upon with a smart contract. And because the contract is published on the publicly visible blockchain digital ledger, and the code is virtually unmodifiable, then the contract ensures that the terms are met.
Because a smart contract is visible on the blockchain ledger, they allow for great transparency than previously private contracts. A smart contract use case can be to provide services along a supply chain. Smart contract technology can be used to complete a sales transaction, to agree to legal contracts, and for a basic cryptocurrency exchange.
Smart contracts can be used in other areas of business relations. They are becoming a reality as a decentralized autonomous organization (DAO). Another possible smart contract use case is within contract law for resolving disputes or to be used as the original legal contract agreement. Smart contract logic is the core function of a decentralized application (dApp), such as Popcorn Time, Tor, BitTorrent, and BitMessage.
How Smart Contracts Work
You can think of smart contracts like a vending machine. You put money into a vending machine, make a request, and your treats are served up. A smart contract works on the same principle. Put in the details, make the request, and the code does all the work.
Smart contract code only talks to the blockchain, so it cannot be interrupted or manipulated into completing an alterer task. Instead, it runs automatically to validate a condition, determine where the assets should go, and fulfill any other features of the contract, such as the timing of payment.
While sending cryptocurrency over the blockchain network is good for day to day payments, a smart contract can facilitate long-term payments and greater functionality in financial transfers. A smart contract operates like a piece of software that runs on top of the decentralized network such as the Bitcoin blockchain or Ethereum blockchain.
If you are writing an Ethereum smart contract, then know that just about any type of program can be run on the Ethereum blockchain. This is because the Ethereum blockchain is the first to have implemented a Turing Complete virtual machine built on top of it so that any computational task can be accomplished.
How to Develop a Smart Contract
- Find an open-source Solidity contract as a starting point
- Define the abstract token contract
- Define the abstract store contract
- Write test cases for use with test-driven development (TDD)
- Implement the smart contract code
- Create a custom dev chain for testing
- And then develop your own
You will also need the program Ganache installed. Ganache is a testing tool for creating private Ethereum blockchains so that you can test your code before it is published live to the blockchain platform. And last, make sure to download an Ethereum wallet from MyEtherWallet (Note: Download etherwallet-v3.xx.x.x.zip) as opposed to using the URL-hosted website.
You can then use an online compiler such as Remix in order to write your smart contract code. You might want to walk through these steps as mapped out by Gerald Nash for launching a blockchain on your own machine, deploying a smart contract to it, and interacting with it.
Once you have gone through practice steps, you can then upload your contract to the Ethereum test network (testnet) so that the contract is at least copied to the global Ethereum network. From there, you can still use fake money to interact with it and eventually use real money.
How to Use a Smart Contract
Think of a smart contract as a program that ensures that the operation is completed. This way, users get the security of the blockchain technology but without necessarily needing to use cryptocurrency.
To create a smart contract, you put in the assets, make a request, and the code executes automatically to deliver the assets. The execution is then visible on the blockchain network.
As an example, let’s use a rental agreement and paying rent through the smart contract. Once the agreement has been entered into, you begin by paying rent in cryptocurrency. A receipt, or digital entry key, is provided and held in the virtual contract.
This digital entry key will be delivered by a specified date. If the digital entry key does not arrive on time, then the funds (blockchain) is refunded. If the key is sent before the funds arrive, then the blockchain will hold the key until the funds arrive. The funds and the key are released at the same time, and usually on a specified date. This exchange is also witnessed by thousands of people on the distributed ledger so that the payment for that key is verified.
Once the transaction has passed, then the document is automatically canceled and then the code cannot be interfered with by either party without the other party being alerted to the change.
A rental agreement is just one way that a smart contract can be used. It can also work for insurance premiums, crowdfunding agreements, property law, credit enforcement, breach contracts, financial services, and numerous legal processes.
Blockchain Smart Contracts
Blockchain development uses powerful peer-to-peer networks and if/then commands in order to verify legal agreements. These contracts can be a powerful tool in fintech, and they can be developed in order to streamline financial transactions give substantial power to digital contracts.