Smart Contracts and How they Work?


Smart contracts is one of the most useful tools associated with blockchain, allowing you to transfer anything from Bitcoin or fiat currencies to commodities shipped around the world. This is what they are doing and why they are likely to gain traction.

Smart contracts are self-executed business automation applications that run on distributed networks such as blockchain.

And because it can remove the administrative burden, smart contracts are one of the most attractive features associaating with blockchain technology. Blockchain acts as a kind of database that confirms that a transaction has taken place, while smart contracts perform certain conditions. Think of smart contracts as “if / then” or computers with conditional programming.

When certain conditions of the smart contract meet (when the goods arrive at the port, the two parties agree to exchange cryptocurrencies), automate the transfer of Bitcoin, fiat money, or the receipt of goods shipments. , You can continue your journey. Among them is a blockchain ledger that stores the status of smart contracts.

Understanding tokens and smart contracts

For example, insurers can use smart contracts to automate the release of billing funds based on events such as large floods, cyclones, and droughts. A bill of lading is automatically issued as soon as the cargo arrives at the port of entry and the IoT sensor in the container confirms that the contents are unopened and properly stored throughout the journey.


smart contract
smart contract

They also are the basis for the transference of cryptocurrency and virtual tokens (in essence, a virtual illustration of a bodily asset or utility). For example, Ethereum blockchain`s ERC-20 and ERC-721 tokens are themselves clever contracts.

However, not all smart contracts are tokens, says Martha Bennett, Forrester Research’s chief analyst. “You can run smart contracts on Ethereum that trigger actions based on the absence of ERC20 or ERC721 tokens,” she said. smart contracts can regulate the transfer of other cryptocurrencies such as Bitcoin. Once there is a confirmation of payment, Bitcoin can change hands from seller to buyer.

Bennett pointed out that most enterprise blockchain networks do not use tokens. For those who do, smart contract rules regulate how tokens are allocated and define transfer conditions.

“Still, that doesn’t mean that the token is a smart contract, it all depends on how the token was constructed,” Bennett said. “And the tokens don’t have to be about economic value. Tokens can give you the right to vote for a decision. They don’t have economic value.”

How smart contracts mimic business rules

Smart contracts aren’t really “smart” or legal contracts. They are just business rules translated into software. “People often ask what makes smart contracts different from software for automating business rules and stored procedures. The answer is that the principles are conceptually the same. But smart contracts are. We can support the automation of processes that involve multiple organizations across corporate boundaries. Existing business rule automation capabilities can’t do that, “Bennett said.

This means that the smart contract code runs in an open blockchain ledger, so you can apply the rules not only within the company that coded the smart contract, but also to other business partners who are eligible to join the blockchain.

“In other words, it’s code that works as programmed. If the business rules are poorly defined or the programmer doesn’t work well, the results will be confusing,” Bennett said. “And even with proper design and programming, smart contracts aren’t smart. They work as planned.”

Converting a business rule into code does not automatically turn the result into a legally enforceable agreement (actually a contract) between the parties. There are several initiatives that aim at making smart contracts automatically legally binding. This path comes with difficulties and risks-at least for the time being, Bennett said. This is because there is no agreed standard definition of what a smart contract is.

“And what if the software has an error and the results are bad? Is the resulting loss legally binding?” She added.

smart contract
smart contract

The importance of good data, and ‘oracles’ in smart contracts

High quality programming is important because smart contracts are as good as the rules for automating processes. Is it important again? The accuracy of the data supplied to the smart contract. This is because smart contract rules are immutable as soon as people  use them. Once the user and programmer sign the contract, they can’t change it.

Therefore, smart contracts will not work properly if the data is not true and does not need to be on the blockchain. The data is fed to the blockchain and used for intelligent contract execution from external sources, especially data feeds and APIs.


 The blockchain cannot “fetch” data directly. (These real-time data feeds for blockchain are  “oracles”. They are basically middleware between data and contracts.)

Oracle can be software-based or hardware-based. Hardware-based Oracle could be, for example, an RFID sensor in a freight container that sends location data to intelligent contracting parties. In contrast, Software Oracle could be an application that provides information about the stock exchange, such as interest rate changes and stock price fluctuations, via APIs.

In this case, if you hedge the risk of the stock exchange and the stock price goes up, one party will receive the money and the other party will lose it. Smart contracts that determine what happens require market price data, and APIs for that are provided by the data provider. This causes problems: The parties involved in smart contracts must trust the external data source.

Blockchain and your company

Blockchain can be distributed across dozens or thousands of nodes, but smart contracts do not. They run on a single knot. Blockchain nodes (servers) have no insight into the capabilities of a particular smart contract. Consortiums of companies that are part of the blockchain network need to rely on Oracle to inform smart contracts.

If your company is part of a blockchain consortium (eg supply chain), there is no way to know what is happening with smart contracts. There is no verifiability. Basically, you need to agree with the company running the server that hosts the Oracle and smart contracts that the information entered in the blockchain is correct.

“For that data, you need to access the source, table, and oracle. There is no standard process to ensure that the data is correct and entered correctly. This is a key point of failure. “Gartner told the next vice president. Investigate Avivah Liten.

“Not yet fully developed,” continued Litang. “I talked to companies that are part of the consortium and asked how they know what they are doing, but they say they aren’t. You’re your life. When you have a contract to run, do you want to know what it is? Do you? “

smart contract
smart contract

Potential problems with smart contract data

Since Oracle traditionally sends data from a single source, there is no completely reliable data, according to Sergey Nazarov, CEO of Chainlink, an Oracle startup that uses multiple external sources for Oracle’s data. Nazarov wrote in a white paper that data could be harmlessly or maliciously corrupted “due to a flaw in the website, fraudulent service providers, or honest mistakes.” ChainLink has built development partnerships with Internet and financial services companies such as Google and the Society for Worldwide Interbank Financial Telecommunication (SWIFT)  , which operates one of the world’s largest clearing and payment networks.

According to Nazarov, one party may be working, but the other party chooses not to pay, so it’s a question of how a normal contract today works. There is a possibility of becoming. Not true. “Technologies like smart contracts can’t enforce them,” Nazarov said. “Smart contracts are deterministic. You can absolutely enforce them as long as events related to the terms of the contract occur. ” They are event-dependent. They depend on market events. Insuring IoT data from cars, factories and other devices is a “continuation of Nazarov”. Trade finance relies on shipping data.

In another example, Chainlink created a smart contract for a media company. It held in reserve fees to pay to a search engine optimization (SEO) firm it had hired until news article URLs reached – and then maintained – search engine rankings for a specific period of time.

“Our client hasn’t done any payment or the search engine optimization firm,” Nazarov said. “It was held by this new technology [blockchain and the smart contract] that will programmatically enforce the contract as it was written. That’s the fundamental difference.”

While complicated to develop in the past, constructing smart contracts is becoming easier. New programming tools are emerging that move away from the underlying complexity of smart contract scripting languages, essentially enabling business people to pull together the basics of a smart contract, Bennett said. “We’re even beginning to see tools that allow business people to pull together the basics of a smart contract,” Bennett said. “But this is just the beginning. As some companies already know, it can be difficult to make sure that all network participants are using the same version of smart contracts is.”

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