What are Smart Contracts on Blockchain?

Chris Soriano

• 4 min read
What are Smart Contracts on Blockchain?

Smart contracts are transforming the way we conduct business and process transactions. They enable automated agreements that remove the need for middlemen—saving time, money, and resources. This comprehensive guide will walk you through everything you need to know about smart contracts, from their basic concept to real-world use cases.

Table of Contents

What Are Smart Contracts?

Smart contracts are self-executing computer programs stored on a blockchain that automatically carry out actions once specific conditions are met. You can think of them like a digital vending machine: when you input the right amount of money and select an item, the machine delivers it automatically—no cashier or third-party required.

These automated programs facilitate trusted transactions between parties without intermediaries or central authorities. Unlike traditional contracts written in legalese, smart contracts are pure code, performing actions based on predetermined rules.

How Smart Contracts Work

Smart contracts follow a simple "if-then" logic. They reside on a blockchain network, where multiple computers (nodes) validate and confirm that certain conditions have been met before executing any predetermined action. Examples include:

  • Property Transfers: Once payment is confirmed, the deed is updated automatically.
  • Shipment Alerts: If temperature sensors detect unsafe conditions, an instant notification goes out.
  • Sales Commissions: Reaching a monthly target triggers automatic commission payouts.
  • Inventory Management: Low stock levels initiate a new purchase order.

Once a transaction is processed and recorded on the blockchain, it becomes permanent and tamper-proof, ensuring full transparency. Smart contracts can also interact with one another, forming complex, automated workflows that drastically reduce processing time and human error.

Benefits of Smart Contracts

  1. Speed and Efficiency
    Automation means no paperwork or manual approvals. Contracts execute instantly when conditions are met.
  2. Trust and Transparency
    Encrypted records are shared across all participants, leaving no room for manipulation.
  3. Enhanced Security
    The distributed nature and cryptographic protections of blockchain make contracts difficult to hack or alter.
  4. Cost Savings
    By eliminating intermediaries (and their fees), smart contracts significantly reduce transaction costs.

Applications of Smart Contracts

  1. Safeguarding Pharmaceutical Supply Chains
    • Companies like Sonoco and IBM track temperature-sensitive medications to ensure drug safety.
  2. Retailer-Supplier Relationships
    • Retailers such as The Home Depot use smart contracts to streamline vendor dispute resolution and supply chain visibility.
  3. International Trade
    • Platforms like we.trade standardize trade processes, simplifying and expediting cross-border commerce.
  4. Real Estate and Mortgage Processing
    • Automated contract execution can reduce closing times and paperwork.
  5. Automated Insurance Claims
    • Policy conditions are built into code, triggering instant payouts when events occur.

Security Issues

While smart contracts boast robust security, they're not foolproof:

  • Visible Vulnerabilities: Code is accessible to everyone, so flaws can be quickly exploited.
  • Immutable Bugs: Contracts cannot be easily updated after deployment, making fixes challenging.
  • Historical Hacks: Incidents like the DAO hack ($50M loss) and Parity wallet attacks ($184M loss) highlight potential risks.

Best Practices: Thorough audits, code reviews, and testing can mitigate these vulnerabilities.

Smart contracts are purely technical—machine-executable code that runs on a blockchain.
Smart legal contracts are traditional legal agreements where certain terms or processes are implemented through code. While a smart contract can automate actions, it does not inherently carry legal enforceability unless tied to a broader legal framework.

History of Smart Contracts

  • Nick Szabo introduced the concept in 1994, long before Bitcoin or modern blockchain technology existed.
  • In 1998, Szabo worked on "Bit Gold," an early precursor to Bitcoin, suggesting digital contracts could handle complex financial instruments.
  • Modern-day blockchain platforms, such as Ethereum, built on these foundational ideas to make smart contracts a reality.

Szabo's vision accurately forecasted today's automated business landscape, especially in areas like derivatives trading and financial settlements.

Smart Contract Uses

Smart contracts see widespread adoption across diverse sectors:

  • Financial Services: Automated lending, bonds, and derivatives
  • Real Estate: Digital property transfers and escrow management
  • Supply Chain: Transparent tracking from manufacturer to consumer
  • Healthcare: Streamlined patient records and insurance claims
  • Corporate Governance: Automated shareholder voting processes
  • Employment Contracts: Salary disbursements based on performance
  • Inheritance Processing: Automated fund transfers upon certain triggers

Smart Contract Pros and Cons

Pros

  • Automated Execution: Once conditions are satisfied, the contract self-enforces.
  • Reduced Human Error: Code-driven processes minimize mistakes.
  • Immutable Records: The blockchain's permanent ledger prevents tampering.
  • Lower Transaction Costs: Fewer intermediaries mean cost savings.

Cons

  • Irreversible Nature: Mistakes in the contract code are hard to fix once deployed.
  • Accurate Programming Needed: Smart contracts are only as good as their code.
  • Potential Security Loopholes: Vulnerable code can lead to large-scale financial losses.
  • Limited Complexity Handling: Complex real-world scenarios may be challenging to code.

The Bottom Line

Smart contracts embody a significant leap forward in automated, trustless transactions, opening opportunities across industries to streamline workflows and cut costs. Despite certain limitations—like immutability, potential coding errors, and the need for legal frameworks—smart contracts are fast becoming a cornerstone of the decentralized economy.

Organizations and developers who adopt best practices, conduct rigorous audits, and remain vigilant about security stand to gain substantial benefits from this revolutionary technology.

Frequently Asked Questions

Q: Are smart contracts legally binding?
A: By themselves, no. They are simply automated programs that execute actions when conditions are met. Legal enforceability depends on whether they're incorporated into a larger legal agreement.

Q: Can smart contracts be modified after deployment?
A: Generally, no. Once deployed on a blockchain, they are immutable, meaning bugs or errors are difficult to correct.

Q: Which blockchain platforms support smart contracts?
A: Ethereum is the most popular, but Cardano, Solana, Tron, and Tezos also support smart contract functionality.

Q: How secure are smart contracts?
A: While blockchain technology is inherently secure, coding flaws and exploits remain possible. Thorough audits and testing are essential.

Q: What programming language are smart contracts written in?
A: Solidity is dominant for Ethereum, but other platforms have their own languages tailored to specific needs.