Anyone that is interested in cryptocurrency needs to become better acquainted with how blockchain smart contracts work. Just as traditional contracts bind two parties in the exchange of assets like stocks or property, smart contracts perform a similar function for those who want to engage in transactions with cryptocurrency.
Understanding blockchain smart contracts will help participants develop the best strategies, so they get the most out of their investments into the world of decentralized digital currency.
A blockchain is an incorruptible digital ledger where cryptocurrency transactions are recorded publicly as they take place.
Before beginners can understand what smart contracts are all about, they need to be clear on the definition and purpose of a blockchain. This decentralized technology is a new way to verify transactions and because of its decentralized and open source nature, everything is transparent and therefore protected.
Blockchain information is not stored in any one location, rather it exists across a network of computers. This makes the information in the database easy to verify because it is truly public. Participants can engage in monetary transactions between each other without the need for a third party to facilitate it. But what do smart contracts have to do with blockchains and cryptocurrency?
Why Blockchains Need Smart Contracts
Smart contracts are computer codes built into the blockchain network that both verify and enforce credible transactions between two parties without the need of a third party.
Because blockchains are not controlled by any third party, they use smart contracts to hold two parties responsible for a transaction between them. In the real world, a third party usually does this, such as a bank, broker, mediator, law firm, or government agency. When it comes to cryptocurrency, smart contracts enable the transactions to remain just between those two parties.
A smart contract is a specific special algorithm that:
- Sets up the rules for negotiating the terms of an agreement
- Verifies the fulfillment of the agreement by both parties
- Executes the terms of the agreement
- Allows for more complex transactions
- Updates the ledger when the transaction is completed
In other words, when two parties engage in a traditional contract, there is a third party that resolves any breach of that contract. With cryptocurrency transactions, a smart contract is self-executing and self-enforcing agreement that is built into the program itself.
Smart Contract Analogy
Many beginners that are learning about blockchain smart contracts will hear an analogy used to describe the concept, based on how a vending machine works. The machine stands ready to serve with a strict set of rules it will follow. When a person puts money in and presses the button for their selection, the vending machine confirms that the amount is correct and dispenses the proper food or beverage. There’s no third party, such as a cashier, that takes money, counts it, and distributes the desired item to the customer.
Smart contracts work in much the same way. They stand ready to execute a set of actions when certain steps are begun. If the right action is taken, then the smart contract moves to the next step, and so on. For those that have trouble wrapping their mind around smart contracts, they can think about the vending machine analogy.
What are the Benefits of Smart Contracts?
A smart contract exists as a code, designed to execute one time only to carry out the objective. Once the smart contract is triggered, neither the buyer or the seller needs to worry about whether the other will back away. The smart contract ensure that nothing happens that isn’t supposed to. This is just one benefit of smart contracts in cryptocurrency.
Another benefit of a smart contract is that it is tamper resistant. Only when certain rules and conditions are met, does the action specified within the code trigger automatically. The desired process does not continue until the action is fulfilled, and when it is, the next step executes. If something is done that is not according to the agreed upon rule set, the contract is not enacted. Because of this, when the code is written properly and encrypted, a smart contract is safe from being corrupted.
Yet another benefit of a smart contract is that it is immediate, allowing transactions to take place in real time. In traditional contracts to exchange assets, both parties must take time to verify different aspects of the exchange. When a third party is involved, it can take even longer. Because of the unique nature of blockchain smart contracts, the transactions are carried out and the accounts are automatically settled.
The Future of Smart Contracts
There’s no doubt that smart contracts applied to cryptocurrency add a layer of efficiency and security as participants engage in transactions. However, blockchain smart contracts has a bright future ahead as this new technology expands into other areas of business. As more businesses see the advantages of smart contracts, they can incorporate them in many ways:
- More transparent with customers
- Facilitate direct dealings with clients
- Enjoy greater security
- Lowered operating costs
- Maintain accurate and permanent records
Blockchain technology and the use of smart contracts is already positively impacting all kinds of businesses. When it comes to cryptocurrency, a smart contract strengthens all the advantages of transparency, speed and security while opening the door to even more possibilities.