Introduction
Smart contracts are self-executing programs that automate agreements by encoding the terms directly into code. When an address interacts with a smart contract, the contract executes the agreed-upon actions, such as transferring assets or updating internal accounting. This automation eliminates the need for intermediaries, making transactions more efficient and reducing the potential for human error or manipulation. By relying on code rather than a third parties, smart contracts enable trustless and transparent operations, enabling all parties involved to have confidence in the outcome.
Smart contracts are integral to many blockchain applications, as they are executed by blockchain networks like Ethereum, which functions as a global computer network. These networks process and validate the conditions set within each smart contract, updating the state of the contract with every new block added to the chain. This decentralised execution validates that smart contracts run precisely as programmed, without the risk of interference or manipulation. The combination of immutability and public auditability (transparency) in smart contracts provides a high level of trust and security, making them a foundational element in the development of decentralised applications such as identity, finance, and more.
How smart contracts work
Here’s a more detailed breakdown of how smart contracts function on Ethereum and EVM-based networks:
- Interaction and Execution: Once a smart contract is deployed, it awaits interactions from users or other contracts. When a transaction is submitted to the smart contract, it triggers the contract’s code. For example, in a decentralised liquidity protocol, a smart contract might transfer funds from a liquidity pool to a borrower upon the completion of certain criteria, such as collateral verification and interest calculation.
- Consensus and Validation: In blockchain networks like Ethereum, the execution of smart contracts is validated by a consensus mechanism. Each node in the network processes the contract’s code and verifies that the conditions are met before executing any actions. This decentralised validation enforces that the contract operates consistently and fairly, according to its programmed logic.
Benefits of smart contracts
Smart contracts offer several significant benefits that enhance the efficiency, security, and reliability of transactions:
Predictability: By encoding the terms of an agreement directly into code, smart contracts validate that actions are carried out exactly as specified. This predictability minimizes human error and operational inefficiencies.
Trustless Operations: One of the defining features of smart contracts is their ability to operate in a trustless environment. Trustless means that parties involved in the contract do not need to trust each other or a third party; they can rely on the code to enforce the agreement. This trustless nature is achieved through the blockchain’s decentralised architecture, which enforces that the contract’s execution is transparent and tamper-proof.
Transparency: All interactions with smart contracts are recorded on the blockchain, creating an immutable and publicly accessible ledger. This transparency allows participants to verify the contract’s terms and actions, promoting accountability and trust. Any changes or updates to the contract are visible to all network participants, ensuring that the contract operates in an open and transparent manner.
Security: The decentralised nature of blockchain networks provides a high level of security for smart contracts. Once deployed, smart contracts are protected by the blockchain’s cryptographic algorithms, making them resistant to tampering and unauthorized access. The immutability of the blockchain enforces that once a contract is written and deployed, its terms cannot be altered without network consensus.
Cost Efficiency: By eliminating intermediaries such as brokers, agents, or legal representatives, smart contracts reduce transaction costs. The automation of processes and the removal of middlemen streamline operations, leading to cost savings for all parties involved. This efficiency is particularly valuable in complex financial transactions, global transactions, and multi-party agreements.