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What are Smart Contracts, and How Do They Work?

We all use various apps on a daily basis. It could be a calendar, a shopping app or a game. Behind the beautiful UI interfaces, these apps usually perform a certain set of instructions incorporated by their developers. That being said, smart contracts also perform the same function.

However, with smart contracts, there are no middlemen holding your data or verifying it. Instead, the blockchain holds your information and also verifies it.

How Does a Smart Contract Work?

First, Let’s imagine a traditional online transaction that does not involve a smart contract. For example, buying a car online. To achieve this, you need a car listing website, a payment system, a communication method, and a way to register the car under your name with the relevant authorities.

Each of these elements requires you to trust the service providers. Additionally, the entire buying process is controlled by different individuals or companies.

A smart contract removes the need to trust several parties when buying something. How? Because smart contracts are:

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Autonomous: That is they operate automatically without needing human intervention.

Third-party free: Meaning smart contracts do not require a middleman to verify them.

Secure: Smart contracts adopt cryptography to prevent records from being altered.

Transparent: Every transaction on a smart contract is publicly displayed on a blockchain for everyone to see.

Inside a Smart Contract

Smart contracts are created to implement the terms of an agreement, just like regular contracts. It could be an exchange of digital assets, proof of identity and tokenized rights, among others. So once the predefined conditions are fulfilled, the smart contracts will execute automatically.

Who Created Smart Contracts?

The phrase ‘smart contract’ was discovered in Nick Szabo’s academic paper written in the 1990s. Szabo is a prominent cryptographer and computer scientist that developed crypto known as Bit Gold before Bitcoin launched.

The famous cryptographer originally provided basic use cases for smart contracts, like enforcing contractual arrangements and fraud reduction. However, in his 1996 paper, he included other potential purposes of a smart contract, such as smart property and digital cash.

How Do Decentralized Applications Use Smart Contracts?

A single smart contract can only be used for one transaction type. However, a decentralized app or dapp can combine multiple smart contracts to perform sophisticated things.

Some Notable Dapps

MakerDAO: It is a decentralized finance (DeFi) dapp that allows users to borrow and lend crypto without requiring an intermediary.

Uniswap: It’s a decentralized crypto exchange that lets anyone swap Ethereum-based tokens.

Axie Infinity: It’s a play-to-earn (P2E) game that allows players to buy and breed NFTs of monsters and then battle with them.

Argent: It’s an Ethereum wallet that adopts smart contracts to simplify concepts like private keys and addresses.

Who is Using Smart Contracts?

Despite smart contracts being relatively new, several crypto projects have already adopted the technology. They are largely used in the DeFi world, but some governments and companies have started experimenting with them. They include:

Ubisoft: The video gaming firm has created smart contracts that allow users to purchase, claim and transfer unique NFTs based on its famous Rabbids gaming franchise.

Dutch bank ING: The institution used smart contracts to create a blockchain-based payment and settlement system called Fnality.

The Swedish Government: It is testing a blockchain-based land registry developed on smart contracts to verify land ownership.


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