Crypto Basics

What is a Smart Contract?

June 23, 2022
6 min
What is a Smart Contract?

The definition of a smart contract is "a protocol for regulating contracts."

A smart contract is a special protocol intended to contribute to, verify, or implement the negotiation or performance of the contract.

Essentially, you can write a protocol that'll execute an agreement or verify a piece of information without needing a third party like a lawyer or mediator.

By removing this third party, you actually increase levels of safety, security, and non-bias from the agreement; this is because smart contracts are trackable and irreversible and contain all of the information and terms of the agreement and execute all envisaged actions automatically.

You can create a smart contract on multiple different blockchain networks, including Solana, Ethereum, and Cardano.

The idea of a smart contract was first conceptualized by computer scientist and cryptographer Nick Szabo in 1994. But, technology at the time couldn't support or build such a protocol.

Smart contracts are important because they remove centralized middlemen in contexts that require trusted third parties to help facilitate value transfer, such as a clearing house that facilitates trading between buyers and sellers.

Relative to smart contracts, middlemen waste significant time and money as well as create centralized points of failure.

How Do Smart Contracts Work?

Smart contracts are built from code that will automatically execute an order once the parameters of the agreement have been met. The terms of the contract are agreed upon by both parties involved in the transaction.

Once the terms have been agreed upon, the instructions are then written into code. The code will consist of various conditional statements that will account for any possible scenario and how the smart contract should operate if this particular scenario happens.

The code is stored and passed around the blockchain network, with all computers of the network now able to execute the code. The contract will only execute once all participants verify the code and contract criteria are met.

This reduces human labor and automates the entire process without any errors. Once your smart contract is live, human intervention isn't needed at all, reducing labor costs and automating processes without the possibility of human error.

What is the need for smart contracts?

Smart contracts provide security and transparency and can remove layers of bureaucracy in certain contexts.

Smart contracts offer large systems and institutions a credible means of simplifying the amount of coordination needed to contract with third parties. In the next section, we explain some of the benefits of smart contracts.

Cost and Time Saver

By removing the middleman and large intermediaries from a process, you'll significantly reduce costs, and the transaction or process itself will become faster.

Smart contracts will reduce admin and labor costs, making transactions and processes cheaper and easier for people and businesses.

You'll still rely on intermediaries like banks and insurance companies to create the smart contracts, but the fees they charge will be unjustified, meaning fewer people will be willing to pay them.

Incredible Security

Once you write the code of a smart contract, it cannot be tampered with; it will work in the way they are intended to and cannot be hijacked. The only issue is that you need to ensure that the code that you write is accurate with zero bugs.

Carrying out transactions between multiple parties doesn't require you to trust the other party because the smart contract code deterministically enforces the rules of the contract.

Nonetheless, security is still a concern because the logic of a smart contract could be incorrect. This is why it is typical for smart contracts to be carefully audited by security experts before deployment onto the blockchain.

If the contract's logic is correct, then its code can execute trustlessly, and the results of any execution will be verifiable and immutable.

Transparency and Reliability

Thanks to smart contract technology, all transactions are stored on the blockchain. Therefore, every transaction made is completely transparent and can be verified.

No one can tamper with the data stored on the contract, which makes them more reliable than traditional paper or spreadsheet records.

Not only that, but both parties will work to write the smart contract, meaning that there will be no room for backtracking or not fulfilling their side of the agreement.

Safe Storage

Smart contracts store vital data that in the event of a data loss on other systems, the data held on the smart contract can be retrieved as all information is permanently stored on a blockchain.

Certainty of Transaction

Smart contracts operate by code; if the pre-agreed criteria are met, the smart contract will execute with zero hesitation. There will be no chance whatsoever of fraud, hesitation, or backtracking.

Autonomous

Automation is most certainly the most significant advantage of using smart contracts. The contract executes on its own and with zero need for human intervention.

No other action is required once the code is written and terms are agreed upon. Businesses will be able to automate several aspects of their operation, resolve trust issues and reduce costs within business processes.

Example Use Cases

Travel Insurance

If you are going on vacation and take out flight insurance using a smart contract, and your flight got canceled, that contract could be executed to determine if your claim should be paid out. Since your flight was canceled, and this is easy to prove, the smart contract would likely pay out your claim immediately.

Suppose you take out an insurance policy using a current-day insurance company. In that case, the insurance company would evaluate your claim and can decide whether or not to pay you or begin some sort of investigative process that consumes time and resources.

Insurance claims can take weeks and sometimes months to close; smart contracts will remove this lengthy and tedious process.

Mortgages

Another example of how smart contracts can be used in the real world is in the approval of mortgages. If you are a homeowner or broker, you know better than anyone that mortgages can take up to two months to approve.

Smart contracts could significantly reduce this time to just a few days if the person seeking the mortgage has all the relevant information and meets the parameters of a smart contract that writes mortgages.

Healthcare

By using smart contracts in the healthcare sector, you could store patients' health records on a private or hybrid blockchain. Smart contracts could help to scour millions of records to perform analysis of patient information to make a hospital more efficient or to ensure the smooth running of the internal supply chain.

If the health sector adopts technology such as health bracelets, it will register all of your information such as blood pressure and heart rate.

This vital information could then be communicated to healthcare professionals using a smart contract to provide a live data feed; if any of the health parameters cross, the relevant people can receive a notification.

The smart contract will notify you, your family, and a healthcare professional about your current state of health; it could even go as far as ordering your medication.

Supply Chain Management

Paper-based supply chain management is a complete disaster.

The bureaucracy of gaining approval, and the tedious task of tracking, increase the chances of fraud, loss of materials, and costly mistakes. Home Depot currently uses blockchain technology to resolve disputes with its vendors.

Smart contracts can help manage the inventory and automate payment and tasks. Warehouse managers will be able to see real-time stock levels and an accurate understanding of how long it'll take to restock.

This will, in turn, improve delivery times thanks to smart contract data that can be collected and analyzed. Clear records of when items are most popular will allow businesses to plan ahead, avoiding overstocking and tying up money in products they won't sell.

Digital Identity

If you, for some reason, have to verify your identity or somewhat private details of your life to an institution, you can completely streamline the process by storing your job, bank, and demographic details on the blockchain.

And by using a smart contract, this information can be shared with any person or entity you wish; it can be pulled from the blockchain instantly. The KYC process will be instantaneous. A benefit of this is that you can control which information you share, meaning you're in control of your own information.

Parcl Smart Contracts

Parcl uses multiple smart contracts across its synthetic real estate and token swapping protocols. Prices of Parcl assets – tokens that represent the price per square foot in a given geographic area–are determined using the Parcl protocol's property valuation database.

Traders use the Parcl AMM smart contract to trade Parcl assets. The contract custodies tokens and facilitates token swaps as opposed to a centralized trading company performing value transfer and custody.

Similarly, Parcl assets are created, or minted, when users deposit collateral into a vault against which they can mint pAssets. The contract ensures that a vault cannot mint more Parcl assets than it has collateral to back the pAssets according to a risk parameter set by the protocol.

The process of evaluating collateral and Parcl asset dollar values to assess the risk of minting new Parcl tokens is all handled via smart contract logic that underwrites and manages the risk as well as handles internal accounting of debts.

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