The term smart contract was first coined by Nick Szabo in 1994. They are digital protocols used to enhance performance, verify and negotiate contracts on behalf of parties involved in a transaction.
Analogy 1:"What Is a Smart Contract? A simple analogy for understanding the purpose would be pizza delivery. In this example, a pizzeria promises 30-minute delivery for a pie or money back guaranteed. The pizzeria would then create a smart contract with a customer ordering a pie." ~Investopedia
Analogy 2: Perhaps the best metaphor for a smart contract is a vending machine, as described by Nick Szabo. With the right inputs, a certain output is guaranteed. A smart contract, like a vending machine, has logic programmed into it. Like how a vending machine removes the need for a vendor employee, smart contracts can replace intermediaries in many industries.
~Ethereum.org
Smart contracts work in an algorithmic way and carry out transactions where the trust, consensus, consequences, and payments will be decided by the smart contract based on the set rules.
Smart contracts usually work with blockchain. If on a blockchain, the smart contract has to use the consensus protocol to “verify” the state of affairs or depend on validators and reporters to confirm and report the end results before triggering the ending set of commands like making payments.
How Smart Contracts Work
Smart contracts follow statements that are written as code on a blockchain. A network of computers executes the actions when conditions that were set have been met and verified.
These actions could be releasing funds to appropriate parties, sending notifications, registering a vehicle, or issuing a ticket.
The blockchain is updated when the transaction is completed. This means that the transaction cannot be changed and only the parties who have been granted permission can see the results.
There can be several rules in a smart contract needed to satisfy the participants that the tasks will be completed satisfactorily.
While making the terms, participants are required to determine how transactions and their data are represented on the blockchain and agree on the rules that govern the transactions.
Normally, they must explore all possible exceptions and define a framework for resolving disputes.
The smart contract is then programmed by a developer. However, most organizations that use blockchain for business provide templates web interfaces, and other online tools to simplify the making of smart contracts.
Pros of Smart Contracts
1. Speed and Accuracy
Once the specific rules in a smart contract are met the contract is executed immediately. This is because smart contracts are digitally automated.
There is no paperwork to process and therefore no time spent on fixing errors that result from manual filling of documents. Using smart contracts is therefore faster and more accurate.
2. Transparent and Trustworthy
Since there is no third party involved, there is no reason to question whether the information on the smart contract has been altered for another person’s benefit. Encrypted records of transactions are shared across participants.
3. Secure
Blockchain transaction records are encrypted and consequently very difficult to hack. Also, since each record is connected to previous and next records on a distributed ledger, hackers would have to alter an entire chain to change a single record.
4. Savings
Smart contracts eliminate the need for a third party to handle transactions, This allows the code to be executed 24/7 with no human errors involved.
Why We Need Smart Contracts
Smart contracts enable developers to build a wide variety of decentralized apps and tokens.
They are useful in several things from new financial tools to game experience.
Moreover, they are stored on a blockchain like any other crypto transaction. Once a smart contract is added to a blockchain, it can’t be reversed or altered.
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