What are Smart Contracts on Blockchain? How do They Work?

Nishita Gupta
Nishita Gupta April 13, 2023
Updated 2023/04/13 at 11:42 AM

You probably have heard of smart contracts if you have read any news on Web3 or blockchain

You’ve undoubtedly heard about smart contracts if you’ve read any news about Web3, the metaverse, non-fungible tokens (NFTs), or cryptocurrencies. You’re undoubtedly also curious about how they operate legally and what they could imply for the future of your company.

A key component of Web3, the developing decentralized internet that many believe is in the future, is smart contracts. As Web3 develops, companies (including attorneys) that are knowledgeable in smart contracts may have an advantage over their rivals.

What is a Smart Contract?

A smart contract is not the same as a standard legal contract. It would be more accurate to describe it as computer software, similar to an automated digital escrow agent, that makes sure things are done by the agreements between parties.

Smart contracts are programs with code that, when particular conditions are met, cause certain actions to be taken. This automated execution process makes sure that everyone keeps their end of the bargain. Many smart contracts are enforceable in court like conventional contracts, so if one party is unable to carry out their commitments, there may be legal repercussions.

Blockchain technology, a decentralized, digitally distributed ledger with a cryptographic foundation, powers smart contracts. Instead of being on a single server, it exists on a network of computers. Furthermore, it is immutable, which means that no contractual party may change the terms or conditions of the smart contract once it has been distributed to the decentralized network without the network’s consent.

How Do Smart Contracts Work?

Smart contracts are rather easy to comprehend. The smart contract automatically carries out the agreed-upon activities when a predetermined condition or combination of circumstances is satisfied. These might be anything from delivering notice to your phone to moving money between parties. The simplest illustration is a vending machine.

When a smart contract is placed into use, it begins to “listen” for updates from an input oracle, which links the blockchain to outside inputs. Smart contracts may transmit signals to other systems to cause them to take action thanks to output oracles.

The oracle notifies the smart contract when the transaction is finished, and the blockchain then changes to reflect the successful completion of the transaction. Thus, for instance, someone might purchase a vehicle with Bitcoin. The smart contract might ping an IoT device inside the automobile to unlock the door as soon as it detects the signal that the payment has been completed.

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