What is a smart contract? The principle of operation and the role of Smart Contracts

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If you’ve been involved in the cryptocurrency investment market, you’ve probably heard the term “Smart Contract” before. However, not everyone fully understands and effectively uses this type of contract in their profit-seeking process. To help you understand more, Tiệm Coin will delve into the details of Smart Contracts along with other important issues in the content below.

What is a Smart Contract?

A Smart Contract is a program stored on a blockchain system that runs only when pre-programmed conditions are met. These contracts usually automatically execute agreements, allowing both parties to achieve results quickly without the need for third-party intervention or lengthy processing times. Smart Contracts also automate the execution process, ensuring that the steps are carried out according to the terms of the contract.

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How did Smart Contracts come about?

The term “Smart Contract” first appeared in 1993 by American computer scientist Nick Szabo. He is also the inventor of the virtual currency called “Bitgold” in 1998 (10 years before Bitcoin appeared).

According to him, a Smart Contract is a transaction protocol executed by a computer based on the terms of the contract. He proposed executing contracts for composite assets such as combining bonds and derivatives (options and futures contracts).

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Smart Contracts were initially used to represent a set of promises (conditions) specified in digital form. By 1998, they were employed to describe objects in the rights management class of the Stanford Infobus system—a project at Stanford’s digital library.

So, since its inception until now, what programming language has been used to write Smart Contracts? There are many programming languages used for writing Smart Contracts such as Solidity, Golang, JavaScript, SQL, C++, Java, and more.

Principles of Smart Contract Operation

Smart Contracts operate based on the “if/when..then…” command, which is encoded and transferred into the blockchain system. When the pre-programmed terms of the contract are met and verified, the entire execution process begins.

The execution content could include disbursement, vehicle registration, notification, or ticket issuance. After the transaction session is completed, the blockchain will be updated. This means that these transactions cannot be modified, and only authorized parties can view the results.

In Smart Contracts, there can be multiple terms to satisfy both parties to ensure the execution process is completed fairly. To establish these terms, participating parties must determine how transactions and their encrypted data will be handled on the blockchain. The “if/when..then” command governs the transaction, understanding all possible exceptions, and defining the framework for dispute resolution.

Afterward, software developers will program the Smart Contract, although more and more businesses on the blockchain provide ready-made templates, web interfaces, and other online tools to simplify the process of drafting Smart Contracts.

There are 4 important factors for a Smart Contract to function:

  • Contracting parties: The parties involved in the contract execution, including those authorized to access, monitor processing progress, and contract content.
  • Contract terms: The terms stipulated in a chain form, specially programmed for the participating parties to agree on.
  • Digital signatures: Participating parties in the smart contract agree to deploy the terms of the digital signature and must perform actions through the digital signature.
  • Decentralized platform: At the completion stage, the smart contract needs to be uploaded to the blockchain. The blockchain chain continues to distribute data to nodes and stores it, which cannot be adjusted.

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The operation of a smart contract can be described through the following 4 steps:

  • Step 1: The parties involved in the smart contract use digital signatures to confirm their identities and agreement. The smart contract is written in a programming language and is specially encrypted.
  • Step 2: The smart contract is uploaded to the blockchain and distributed, copied by nodes in the network. Each node will verify the validity of the contract and confirm it into a new block.
  • Step 3: When there is a deployment order, the smart contract will automatically execute as programmed. A computer network will perform actions when the verification conditions are met. Actions may include: making payments, registering vehicles, issuing invoices, sending notifications…
  • Step 4: After completing the actions, the results will be recorded and updated on the blockchain. Authorized parties can view the results and cannot arbitrarily change transactions.

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Advantages and disadvantages of Smart Contracts

Advantages

Fast, Accurate, and Efficient

When conditions are met, the contract will be executed immediately. Because smart contracts are digital contracts, there is no need to spend time processing paperwork and avoiding common errors when drafting documents.

Transparent and Reliable

There is no need to worry about information being altered for personal gain, as the encryption of the contract is only shared between the two parties involved, without the presence of a third-party intermediary.

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High Security

The records of the execution process are encrypted and transferred to the blockchain, making it difficult for hackers to attack. Furthermore, each record is closely linked to previous and subsequent records in the distributed ledger, so if a hacker wants to change a record, they must change the entire chain.

Cost-effective

Smart contracts can be executed without the intervention of a third party, thus avoiding delays and associated costs.

Disadvantages

Smart contracts also have some disadvantages and challenges that need to be addressed, such as:

Immutable

Once a smart contract is uploaded to the blockchain, it cannot be edited or canceled. This can cause problems when there are changes in the conditions or desires of the parties involved.

Difficult to resolve disputes

Smart contracts do not have a mechanism for resolving disputes when unexpected or unclear situations arise. Participants may have to seek other organizations or individuals to resolve them, which can be time-consuming and costly.

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Dependent on blockchain technology

Smart contracts operate based on blockchain technology, so they also have to endure the limitations of this technology, such as: scalability, performance, energy consumption, etc.

Lack of legal recognition

Smart contracts are not yet widely recognized and explicitly regulated by the laws of nations. This can pose difficulties and legal risks when applying smart contracts in international transactions or those involving legal rights and obligations.

Applications of Smart Contracts

Smart contracts can be used in various industries to streamline and automate business operations worldwide, especially in the cryptocurrency field. This is a powerful tool with many important applications in the development and management of digital currencies:

Bitcoin has laid the basic foundation for smart contracts on the Blockchain. However, Ethereum has developed smart contracts to become a fundamental business running on the ETH platform, helping applications run accurately, without interruption, forgery, or interference from third parties.

Smart contracts eliminate intermediaries from transactions when dealing with cryptocurrencies, overcoming security, legal, fraud, and auditing issues, saving time and resources compared to transactions through intermediaries.

A network of Smart Contracts along with blockchain technology with decentralized/distributed characteristics helps operate the cryptocurrency exchange system effectively.

Moreover, smart contracts are also applied to the activities of other organizations such as: Efficiently protecting Sonoko and IBM’s drugs, enhancing the relationship between retailers and Home Depot’s suppliers, WE.Trade organizing international trade activities more effectively, etc.

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Dispute Resolution

Discrepancies in financial settlements are costly and take a lot of time to research and resolve. Smart contracts systematize agreed-upon business rules and automatically execute processes such as identifying discrepancies, reconciling documents, resolving transactions, and disputes.

Flexible Supply Chain Building

IBM’s blockchain supply chain solution uses smart contracts to streamline the flow of goods by automatically executing the next steps when conditions are met, such as shipping, distribution, and monitoring the status of goods using devices throughout the process. Participants can prevent disruptions if there are any issues.

Redefining Bank Guarantees

A group of banks has digitized and converted the bank guarantee process for both financial guarantees and performance guarantees through the blockchain system and smart contracts. Lygon – a new platform allows applicants, issuing organizations, and beneficiaries to obtain legally binding guarantees within one day.

After reviewing the information above, Tiệm Coin hopes that you have a better understanding of smart contracts and their significance in the cryptocurrency trading field. Smart contracts play a crucial role in the development of cryptocurrency exchanges. Understanding this type of contract will help you apply it effectively in your investment process, thereby optimizing profits.