Conventional contracts don’t have the power to enforce the terms they represent on their own. Instead, a third party such as a government is needed to monitor the execution of such contracts and guarantee that both parties will fulfill their side of the agreement.

But what happens when the contract is breached by either party? The parties have to rely on a middleman to remedy the breach, which is often slow and ineffective.

However, intermediaries may no longer be needed to manage contracts, thanks to recent advances in blockchain technology. Instead, people can now create and enforce contracts on their own for the first time in history, thanks to smart contracts.

Nick Szabo, a computer scientist, proposed a computer protocol in 1994 that not only specified the parameters of a transaction but executed it as well. Unlike traditional contracts, which require attorneys or governments to enforce the described exchange, smart contracts are self-enforcing.

Now let’s take a look at what a smart contract is and how smart contracts work.

What Are Smart Contracts?

Smart contracts are essential components of blockchain networks such as Ethereum. They are best described as computer code that can be hosted and used in a blockchain environment.

Each smart contract is made up of instructions that specify the criteria that, when met, result in specific outcomes. For example, in the LendeXe P2P protocol, the smart contract defines Borrowing Interest for a loan. These change dynamically depending on supply and demand. Furthermore, smart contracts enable multiple parties to achieve a shared goal in an accurate, fast, and secure manner via decentralized blockchain networks rather than a centralized server.

Since they aren’t owned by a single authority or exposed to single points of attack by third parties, crypto smart contracts provide a unique automation infrastructure. When used for digital agreements, smart contracts minimize counterparty risk, lower costs, and improve transparency.

How Do Smart Contracts Work?

Now you know what smart contracts are, but how do they work?

Every smart contract essentially follows if-then logic. As soon as the contract’s criteria are met, the contract will be executed.

A vending machine is one of the most simple and effective smart contract examples. When you insert the necessary cash amount and make your decision, the vending machine will dispense the item you selected. The contract conditions are clear, and transactions can occur on their own. As in any other lending protocol, LendeXe P2P Lending will liquidate a collateral if the price of this deposited token falls below a certain value and no further tokens are deposited in time. The smart contract performs this task automatically and follows certain rules that are transparent to everyone. For this reason, LendeXe’s P2P Lending smart contract has also been audited by Certik.

While an individual smart contract is accountable for a specific action, several smart contracts can be combined to accomplish more complex tasks. This complexity gave rise to decentralized apps (dApps) and greatly enhanced the functionality of smart contracts.

Decentralized crypto exchanges are a good example of dApps.Through different smart contracts, users can exchange different crypto assets with one another on these exchanges.

Some other smart contract example use cases include:

  • trading, betting, and auctions
  • inventory management
  • financial services
  • ownership and identity management
  • government
  • clinical trials

There are also several smart contract programming languages, the most prominent of which is Ethereum’s Solidity. Thanks to these tools, any developer can create smart contracts and deploy them on a blockchain network as needed.