What is a blockchain smart contract?

Smart contracts represent one of the most disruptive aspects of blockchain technology. They shift power away from centralised to decentralised control through censorship-resistant peer-to-peer transactions. This removes overhead costs and middlemen while retaining accountability. 

Smart contracts are self-executing agreements encoded on a blockchain. By automating a sequence of events and removing third party intermediaries, smart contracts provide a new opportunity for transparent, efficient and trustless interactions. 

As blockchain adoption grows, smart contracts will continue changing mainstream industries. Their programmable and self-executing nature has unlocked opportunities to reimagine agreements ranging from event ticketing and supply chains to real estate purchases. 

By merging blockchain’s resilience with legal logic, smart contracts provide the backbone for the decentralised economy of the future.

In this article we will break down how smart contracts work and their key use cases.

How do smart contracts work?

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Smart contracts are self-executing programmes stored on a blockchain that run when predetermined conditional probabilities are met, following the ideal that “if X happens then Y occurs”. They are designed to automate the execution of an agreement so that all participants can be immediately certain of the outcome, without any intermediary’s involvement or time loss.

Once the smart contract’s logic and rules are established by the involved parties, the code is deployed on a blockchain network like Ethereum. When the predefined conditions specified in the code occur, the smart contract automatically kicks in to execute the corresponding actions like releasing funds to the appropriate party. For example, a supply chain smart contract could automatically trigger signed invoices, shipment notices, transfer of ownership upon delivery, and payment transfers without requiring user or lawyer involvement at each step.

The deterministic nature of smart contracts provides reliability and reduces transaction costs associated with traditional contracts. By embedding rules governing every party’s obligations, smart contracts allow credible transactions between all participants without centralised enforcement. The transparency of activity records on public blockchains also guarantees accountability in case of disputes. Ultimately, smart contracts minimise counterparty risk and maximise operational efficiency across transactions.

Furthermore, a problem smart contracts face is their isolation from any data, both on and off chain, once executed on the blockchain. Having access to data is particularly crucial for certain types of smart contracts, such as tokenised bonds. Oracles provide a solution to this problem, by creating a form of “hybrid” smart contracts, which allow smart contracts to access external data sources.

If you want to learn more about how oracles work with smart contracts, read our recent article here.

History of smart contracts 

Smart contracts were first proposed in 1994 by American computer scientist Nick Szabo. Nick Szabo defined smart contracts as “a computerised transaction protocol that executes the terms of a contract.” 

Szabo envisioned bringing more advanced functionality and efficiency to digital agreements by having self-executing contracts with outcomes directly tied to programmatic logic. However, the technology did not yet exist to implement Szabo’s vision on a large scale. It took until the launch of Bitcoin in 2009 for the first basic smart contracts to be introduced on a blockchain network. Bitcoin allowed users to transfer value based on meeting conditions like providing a valid private key to authorise the transaction. This represented the first major milestone in smart contract functionality. The Bitcoin network later expanded to support multi-signature transactions requiring agreement between multiple parties to release funds.

While innovative, Bitcoin only enabled basic preset logic. The real breakthrough came with the Ethereum blockchain in 2015. As opposed to Bitcoin's limited scripting language, Ethereum introduced Turing-complete smart contract capabilities. This allowed developers to write sophisticated generalised applications that could self-execute complex logic autonomously on the blockchain. Decentralised Apps (dApps) could now leverage smart contracts to enable use cases ranging from decentralised finance to supply chain tracking, identity platforms, governance protocols, NFT marketplaces, and more. Ethereum unlocked nearly endless possibilities to codify business logic transparently and securely on a tamper proof ledger. Today, Ethereum dominates as the leading smart contract blockchain powering Web3 innovation across industries.

Smart contract use cases

Tokenisation (Tokens)

Token smart contracts codify the creation, tracking, and ownership transfer of blockchain-based assets like utility tokens, governance tokens, security tokens, and NFTs. These tokens become programmable when issued via smart contracts that let developers bake in special features, configure vesting schedules, restrict transfers, and more. Smart contract tokenisation unlocks verifiable digital ownership rights.

Financial Products (DeFi)

Decentralised Finance (DeFi) relies extensively on smart contracts to offer traditional financial services in a permissionless, trustless manner. Smart contracts enable decentralised exchanges, loans, derivatives, payments, asset management, and more without intermediaries. For example, lending protocols like Aave use smart contracts to accept collateral from borrowers before algorithmically dispensing loans based on predefined collateralisation ratios for specific assets.

Gaming 

Smart contracts introduce provable randomness and fairness into blockchain-based games which is key for rewarding players and assigning limited-supply digital collectibles. Randomness ensures equal opportunity by preventing biassed outcomes in events like NFT mints or loot box reveals in RPGs. And on-chain verification means game developers can prove events weren't tampered behind the scenes.

Insurance

Smart contract programming enables parametric insurance linked to data inputs like weather rather than individual claims assessment. Users can purchase coverage via premium pools that pay out automatically when pre-agreed conditions written into the policy's smart contract logic pass. For instance, a flight insurance policy may refund customers if airline APIs show a delay over 90 minutes. The automation cuts administrative costs and payout lag.

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Conclusion

Smart contracts represent a breakthrough innovation with immense transformative potential across industries. They enable complex contractual agreements and transactions to be automatically executed and settled on blockchain networks without requiring trusted intermediaries. 

By merging code with legal contracts, smart contracts digitise and automate multi-party interactions in a faster, cheaper, more secure way. Their unique blend of automation, cryptographic security, transparency and tamper-proof execution promises to revolutionise antiquated contractual models. 

Smart contracts already facilitate everything from insurance claims and gaming rewards to tokenised assets and decentralised finance. Although adoption is still nascent, smart contracts are poised to become a critical component of the emerging digital economy across trade, law and finance as more legacy systems transition to blockchain infrastructure.

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Sources:

https://chain.link/education/smart-contracts

https://www.coinbase.com/learn/crypto-basics/what-is-a-smart-contract

https://www.investopedia.com/terms/s/smart-contracts.asp