What Is A Smart Contract? How Does it Work?

Smart Contract Introduction for Dummies

What is a Smart Contract?

A smart contract is a computer program or a transaction protocol which is intended to automatically execute, control or document legally relevant events and actions according to the terms of a contract or an agreement.

The blockchain is a network of computers that use blockchain technology and can only be accessed by permitted parties. This only means that you don’t have to pay for the services for a middleman, thus allowing you to save a lot of time.

Of course, blockchains have a few problems; however, they are without a doubt quicker, more affordable, and more secure as compared to traditional systems. For such reason, a lot of government agencies and financial institutions are starting to embrace them.

However we should not only consider the positive but also the downside of smart contracts.

Cryptographer Nick Szabo realized that it is possible to use a decentralized ledger for smart contracts – also known as blockchain, digital, or self-executing contracts – back in 1994. This format allows contracts to be converted into computer code that is stored and duplicated. Meanwhile, it is closely monitored by a huge computer network running the blockchain. This technology would also lead to ledger feedback including money transfer and receiving of product and/or service.

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Understanding Smart Contracts

Smart contracts make it possible to perform exchanges without the need of a middleman – e.g. money, shares, properties, or just about anything with a certain value. To help understand smart contracts more easily, let us think of the technology as a vending machine.

Normally, you would visit a lawyer for an appointment, pay for their service, and wait until you get your document. Through smart contracts, all you have to do is deposit your cryptocurrency, and you can then have your document in your account. Smart contracts not only follow the same rules of a traditional contract, they also enforces them automatically.

During a recently held DC Blockchain Summit, Vitalik Buterin, Ethereum’s founder and programmer, explained that a smart contract involves the transfer of money or property to a program. The program will run the code and automatically validates a condition that will determine if the asset must go to a person or back to another or if the funder should be refunded, or a combination of sorts. Meanwhile, the decentralized ledger will store and replicate the document, hence making it more secure.


Suppose you’re going to rent my apartment. To complete a transaction, you pay in cryptocurrency via blockchain. Afterwards, you receive a receipt for our virtual contract. I will then provide you with a digital entry key on a set date.

In the event the key doesn’t arrive on time, you will get a refund through the blockchain. However, if the key arrives before the specified date, you get the key while I get the fee at the specified date. This means you can expect a safe and secure delivery through an If-Then function. If I provide you with the key, I am guaranteed with a payment.

By sending payment in the form of bitcoins, you can get the key. The document will be canceled automatically after the specified date, and both participants will receive a system alert. Neither one of us will be able to interfere with the code without the other party knowing.

Smart contracts are applicable to all sorts of situations. It could either be a financial service, crowdfunding agreement, insurance premium, breach contract, credit enforcement, and more.

A Guide to Using Smart Contracts

Jerry Cuomo, the Vice President for IBM blockchain technologies, believed that smart contracts are applicable for use across all services from financial to insurance. Below are a few noteworthy examples:


Whether you like it or not, we are headed towards a future where everything is automated. Google’s starting the revolution with their smart glasses, phones, and even cars! This is where smart contracts enter the picture.

A good example is Google’s self-driving cars. Smart contracts could play a role by placing a sensor that “predicts” the at-fault party during a crash, along with any other variables. With smart contracts, an auto insurance company can charge their customers differently depending on where and how they operate their cars.


When when think about insurance companies, then we need also to think for example of self driving cars or cars with a parking autopilot. What happens if such a self driving car crashes? By using smart contracts and a blockchain, you could lookup who is actually using that car.

Is it the driver himself? Are there any sensors in use or is the car driving on an automated basis in the moment of the crash?

Using smart contracts, insurance companies would be able to charge rates and fees based client behaviours or and under the conditions customers are operating or behaving. Cars are getting also more and more into the digital world, so imagine a “smart car” is used on a nice clear day without any rain, not much traffic on the daily route you drive to the office.

Such a car could be charged different with a lower rate compared with a car that is driven on a heavy used road on a rainy or stormy day. Insurance companies could adjust rates immediately without any problems by using the smart contract model.


A lot of insiders believe that hacking the voting system is next to impossible. However, smart contracts would give everyone peace of mind by offering an even more secure system. It will take a very extensive computing power in order to hack votes that are ledger-protected, and I believe only God has the power to do so! Furthermore, it would be possible for smart contracts to hike low voter turnout.

The traditional voting system would require a lot of effort by falling in line, confirming your IDs and completing several forms. But with smart contracts, it will be possible to vote online, and the millennials will find voting for their President really convenient.


You can encode and store personal health records on the blockchain through a private key, allowing only to specific individuals to access the data. It could also be used for confirming that research is done in accordance with the HIPAA laws.

You can store surgery receipts in a blockchain and send them to insurance providers. Meanwhile, the ledger can be used for general healthcare management like result testing, regulation compliance, healthcare supply management, and more.


The blockchain is also capable of making workflow and communication a lot smoother due to its accuracy and transparency, not to mention it runs on an automated system.

Normally, business operations will have to experience setbacks and tons of issues as they wait for approval. A blockchain ledger rids of such issue while cutting out variations that could lead to expensive lawsuits and delays in settlements.

Case History

The Depository Trust & Cleaning Corp. (DTCC) successfully processed more than $1.5 quadrillion worth of securities, or around 345 million transactions back in 2015, all with the use of a blockchain ledger.

Real Estate

Smart contracts allow you to further expand your revenue. Normally, renting your house or apartment to someone would require the services of a middleman. Even more, you have to pay for someone to confirm if the rentee has paid the rent properly.

With the ledger, you can save a lot of money. You simply have to encode your contract on the ledger with the use of bitcoins. Everyone can see your contract, and everything is done automatically. Real estate professionals such as brokers, agents, and anyone that has to do with properties can all benefit from it.

Supply Chain

Smart contracts follow an If-Then system. Here is Jeff Garzik’s input on smart contracts:

“UPS is capable of performing contracts that goes like, ‘If I receive cash on delivery at a particular location in a newly emerged market, then another product which is levels above the supply chain will prompt another supplier to create a new item since the market where that existing item was delivered is still developing.’”

In most cases, supply chains are slowed down by paper-based systems with forms that have to undergo many channels just to get an approval. This is grounds for increased risks of loss and fraud. With blockchain, paper-based systems are no longer applicable through a digital version that is more secure and easily accessible for all participants.

Case History

Barclays Corporate Bank records change of ownership with the help of smart contracts. It also allows them to transfer money to other financial institutions.

What is Ethereum

How You Can Benefit from Smart Contracts

Smart contracts can provide you with the following perks:

  1. Backup – On the blockchain, your documents are automatically created with a backup by duplicating them several times over.
  2. Accuracy – Not only will smart contracts provide you with a quick and cheaper operation, it also rids of the errors that you can normally encounter when manually completing forms.
  3. Speed – Manual operations require a lot of time and energy just to process your paperwork. With smart contracts, you’re only using software code for automation. This allows you to save a lot of time.
  4. Autonomy – Basically, you’re the creator of an agreement, meaning you don’t have to call for the services of a broker, lawyer, or any other intermediaries. This also prevents you from being manipulated by a third party mainly because operations are automatically managed by the network.
  5. Safety – Cryptography makes hacking on the blockchain virtually impossible, thus allowing your documents to be secured at all times.
  6. Savings – Since smart contracts no longer require middleman services, you will be able to save a lot of money.
  7. Trust – Your documents are kept safe and protected on a shared ledger, removing the possibilities of losing them.

Jeff Garzik, owner of Bloq blockchain services, define smart contracts as:

“A technology that ensures a very specific set of outcomes. There’s no room for confusion, and the need to take legal action is eradicated.”

“Smart contracts are a turning point for blockchain and businesses. In fact, there have been a few highly specialized cases of blockchain use. One such example is the payment ledger service for Yangon Stock Exchange in Myanmar.

In the exchange, distributed settlement within a trading system that only executes two synchronizations a day is resolved. However, smart contract’s autonomous execution capacities extend the security guarantee of blockchain to even more complex situations. Through this possibility, large-scale companies like Amazon, IBM Bluemix, and Microsoft Azure started offering Blockchain-as-a-Service (BaaS) from the cloud.” – Patrick Hubbard, Head Geek of SolarWinds.

The Downsides

The problem with smart contracts is that it is not yet fully developed. There’s still the possibility of bugs getting into the code. Moreover, there’s still no clear answer regarding how governments should regulate the contracts or tax transactions.

What if, for some unforeseen circumstances, I send the wrong key? What if I send the right key but my apartment ends up getting condemned before the rental date? If this were a traditional contract, it can still be resolved by taking such matter into court.

However, this is a situation that occurs in the blockchain. Hence, regardless of what happens, the contract gets executed. The list of possible issues keeps on going, and experts are still trying to figure them out. These issues are what kept people from participating.

The Possible Future of Smart Contracts

A portion of smart contracts’ future lies in resolving the said issues. In Cornell Tech, for example, lawyers who keep on insisting that smart contracts will become a part of our daily life keep on conducting studies and research regarding such concerns.

The introduction of smart contracts would mean we’re slowly entering the world that exists only in science fiction. Search Compliance, a known IT resource center, claims that smart contracts could have a huge impact in industries like law and automobile.

Lawyers will start producing templates instead of the traditional process of writing contracts like the ones that are on LegalZoom. A lot of industries like merchant acquirers could also start using smart contracts for business operations. In fact, Blockchain Technologies believes that smart contracts will soon merge into a digital and paper content hybrid that verifies contracts through the blockchain and then backed by a physical copy.

Blockchains that Allow Smart Contracts Processing

  1. EthereumEthereum is available to the public and is no doubt the most advanced blockchain for coding and processing smart contracts. It allows you to code whatever you want in exchange for ETH tokens.
  2. Bitcoin – Bitcoin makes financial transactions really easy. However, its document processing capacity is limited.
  3. Side Chains – These are blockchains which are adjacent to Bitcoin and provide a wider range of processing contracts.
  4. NXT – This is a public platform that comes with a fixed selection of smart contract templates. This means you will need to use what’s available, plus you can’t create your own code.

According to Ethereum CTO Gavin Wood:

“Smart contracts’ potential to produce an impact on society is huge. This could be a technology that will serve as a basis for various sorts of social changes. Something that’s worth following.”

With regards to smart contracts’ potential, the scope of industries it could impact is virtually endless. It could range from automobiles to healthcare to finances. The list never ends. We hope we could shed some light on the “What is a smart contract” topic. If you have any questions, leave us a comment.

Thorsten Burger
Thorsten Burger
I am a digitization / Cryptocurrency / NFT enthusiast and author for crypthor.net with a long and extensive experience in the financial and digital transformation industry. I have successfully managed projects around the world, motivated employees to create a variety of beneficial strategic portfolios, digital marketing, e-commerce and platform solutions and supporting the agile transformation.Happy to connect!

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