What are Smart Contracts? How do they work?

Smart contracts are one of the most popular topics such as blockchain. Therefore, in our article, we will explain what are smart contracts and how they affect companies' deals.

 

Central Business Model Leaves its Place to Decentralization

There are three parties in a business relationship in central business models. One of them is the transacting party and the other is the party that approves the contracts. The third party may be the intermediary banks, law enforcement company or other intermediary.

While maintaining business relationships, service companies need intermediaries, which puts customers at risk. In addition to this risk, centralized systems cannot always guarantee payment and contracts smooth execution.

This is why blockchain technology, which enables businesses to create decentralized models, has gained popularity. Blockchain has enabled businesses to gain a different perspective for their transactions and agreements. One of the alternative technologies to the conventional centralized model is the smart contract.

 

Smart Contract Concept

Although the concept of smart contracts seems to have emerged with blockchain technology, it actually dates back to twenty years ago. The concept proposed by computer scientist and cryptographer Nick Szabo in his 1995 article on smart contracts is in line with what smart contracts offer today. We will examine the question of what exactly are smart contracts in the rest of the article.

 

What is a Smart Contract?

Smart contracts are like contracts in the physical world in terms of content. However, they exist in a digital environment and are stored by blockchain technology and represented by a computer program. To explain in detail, smart contracts are actually pieces of software. It stores the rules to fulfill the terms of the contracts and automatically executes the agreed terms.

Thanks to smart contracts, the obligation to stick to a third party is eliminated. In this way, the parties to the agreement directly transact with each other.

For example, consider a start-up that collects money from its supporters for a project. This start-up needs a bank that collects money donated by their supporters and passes them on. That's why both entrepreneurs and supporters have to trust the bank to get the money back to its place. In addition, banks must be paid an additional fee as they mediate money transfer transactions. With smart contracts, the same transaction and more can be performed without the need for an intermediary institution.

A smart contract can be programmed for the time until a project reaches its goal. When the project is successful, the money paid goes back to the product team, if the project fails, the money goes directly to the supporters. Because in smart contracts, data is stored in a distributed manner. Therefore, no one has control of the money. Thanks to this technology, smart contracts are highly reliable and replace third parties.

 

Why Should You Trust a Smart Contract?

Smart contracts designed and functioning within blockchains have some of the features of the blockchain. They cannot be changed or spoiled. In this way, the contract cannot be broken or tampered with by anyone.

The data it contains has been distributed. In other words, it is verified by people on the network like other transactions on the blockchain. If a fraud attempt occurs, other participants will identify and mark such an attempt as invalid.

 

What is the Smart Contract Working System?

Smart contracts are software code, as we said before. The terms of the contract can only be enforced by the parties to which the agreement has been reached. For example, Noah, who lives in Amsterdam, wants to go to Manhattan on vacation and rent a room. Landlord Peter in Manhattan is also renting his room. The two of them can secure their money by making a smart contract between them. So how does this system work?

Noah and Peter would normally reach out to each other through a platform that agreed to protect both landlords and tenants. However, the platform, which serves as a third party, charges fees to both the tenant and the landlord. If a dispute arises, the process may take longer as it will be up to the third party to resolve the issue.

When Noah and Peter make a deal using a smart contract, they benefit from an unchangeable and fast-acting system based on a software algorithm. Thanks to the structure of the smart contract, both parties cannot cheat and keep their money safe.

 

Logical Basics of Smart Contract for Any Occasion

When Peter creates a smart contract that works automatically and transparently while renting his flat for the first time, he creates a universal contract for all future tenants, so he can easily overcome these processes without the need to create a new smart contract for each new guest.

This universal agreement allows anyone using the blockchain to rent out Peter's apartment by following the algorithm above, while at the same time transferring the tenants' rent payment, receiving the address and the apartment code, and providing services for both of them in accordance with the terms of the contract.

Smart contracts can offer an even more universal use without being limited to this. A smart contract can be programmed to be used not only by Peter, but also by anyone who wants to rent their flat anywhere in the world. And these smart contracts can be used for automatic price adjustment, discounts, partial payments, and any special conditions imaginable.

 

Smart Contract Benefits

There are many features that make smart contracts preferable for establishing business relationships and performing transactions. For example, decentralization, transparency and eliminating problems such as fraud are some of them. The benefits of smart contracts that emerged as an alternative to physical contracts and third parties for the execution of their contracts are as follows;

Ability to establish direct relationships with customers without the need for a third party

Decentralized

Reliability

Transparency

Reducing additional costs

Record keeping

 

You can use Finage APIs to build your own smart contract applicaiton or if you are a node protocol business you might use Finage's APIs to implement our data sets into your product.