What Are Smart Contracts in Blockchain and How Do They Work?

Are smart contracts merely a fad in technology? Or a technology that transforms society and has long-lasting effects? Let your questions be answered in this article as we explain what smart contracts in blockchain are all about.

What Are Smart Contracts in Blockchain and How Do They Work?

We now live in a time when more and more people get to have knowledge and exposure to blockchain and cryptocurrency. You might have heard of bitcoin, ethereum, tether, and other prominent digital currencies. But the blockchain technology has evolved beyond just enabling cryptocurrencies.

Take smart contracts, for example. Smart contracts are being used by an increasing number of businesses to seal deals and agreements. You might have encountered this term in your study of blockchain.

You might have asked: Are smart contracts merely a fad in technology? Or a technology that transforms society and has long-lasting effects?

Let your questions be answered in this article as we explain what smart contracts in blockchain are all about. You will also learn how smart contracts work, their benefits and limitations, and their applications.

By the end of this post, you’ll have a complete understanding of smart contracts and how they function.

Let’s get started now! #Sachi

What is a Smart Contract in Blockchain?

Smart contracts rely on blockchain technology for their implementation.

A blockchain is a decentralized network comprised of a continuously expanding list of records (blocks) connected by encryption. Unlike a traditional database, a blockchain network does not have a single central location. All the computers that make up the network share the data stored in the blockchain. As a result, the network is less vulnerable to errors or assaults.

Image source: Financial Times

On the other hand, smart contracts in blockchain are decentralized applications that execute business logic based on events. By executing smart contracts, you can exchange money and deliver services. You can even unlock digital rights to management content as well as change land titles.

In addition to allowing the selective release of privacy-protected data, you can also use smart contracts to enforce the privacy protection.

The programs that support smart contracts can be created, distributed, managed, and updated using several architectures. In addition to being included in various payment methods and digital exchanges, they can also be stored in a blockchain or other distributed ledger platform.

Despite their name, blockchain smart contracts are not enforceable. Programmatically, they execute business logic, which is programmed into them to perform specific tasks, processes, or transactions according to specific criteria. Legal action must be taken if you connect this execution to legally enforceable agreements between parties.

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How Smart Contracts Work

In a smart contract, business logic is encapsulated in a specialized virtual machine that runs on a blockchain or other distributed ledger.

As a first step, business teams collaborate with developers to specify what behavior they expect from smart contracts in different situations. Simple events could be conditions like a utility meter reading threshold, a payment authorization, or a package receipt.

If there is a need for a more complex encoding with a more sophisticated logic then you can make use of smart contracts. Other examples may include calculating the value of a derivative financial instrument, completing a derivative deal, or disbursing an insurance payment automatically in the event of a fatality or natural disaster.

The developers then develop and test the logic in a platform for building smart contracts to make sure it functions as intended. Once the application has been written, a security evaluation is performed by another team.

A smart contract security specialist or a business specializing in smart contracts could be involved. Upon acceptance, the contract is implemented on an existing blockchain or distributed ledger.

Smart contracts are configured to receive event updates from a streaming data source called an Oracle, which has been cryptographically secured once implemented. The smart contract begins to operate once it receives the appropriate combination of events from one or more oracles.

Ethereum founder Vitalik Buterin provides a perfect summary of a smart contract approach:

Image source: Appinventive

Benefits of Smart Contracts

Image source: FinancesOnline

The use of smart contracts has several advantages. Listed below are some of the common ones.


Automating cross-organizational business operations is possible with smart contracts. Businesses can reduce costs associated with running their operations and free up resources, such as the staff required to monitor a complex process that responds to external factors.

Processing Velocity

Business operations that span numerous businesses can be processed more quickly thanks to smart contracts.


Due to their automatic nature, smart contracts eliminate the need for a third party to supervise business-to-business transactions.


The terms and circumstances of these contracts are fully disclosed and available to all relevant parties. Therefore, once the contract is signed, there is no way to cancel it. By doing this, it is made sure that the transaction is entirely transparent to all participants.


The numerous copies of every document stored on the blockchain enable the recovery of originals in the event of data loss. Cryptography protects all documents against tampering, including smart contracts.


Using blockchain ledgers and other distributed ledger technologies, smart contracts can maintain a verifiable record of every activity associated with the execution of complicated processes. This record cannot be modified after the fact.

Additionally, it offers automated transactions that guarantee correctness in contract execution and eliminate the possibility of human error.

Smart Contract Applications

Businesses today aim to speed up existing procedures and streamline their processes. Most companies are using platforms for marketing automation to the fullest extent possible.

Businesses can use smart contracts for a variety of purposes. Here are a few instances of smart contracts that are provided by digital contracts.

Government Services

Government organizations can quickly implement agreements to support democratic and legal objectives with smart contracts.

Smart contracts can be incorporated into a city or local government's voting mechanism. Votes are maintained in a highly secure distributed ledger, making any election-related crimes impossible.

Public data can be maintained on a blockchain and provided to the parties that request it with the aid of a smart contract, keeping the data owner informed.

Healthcare Industry

The healthcare sector is likewise evolving as a result of smart contracts. It aids healthcare organizations in giving patients peace of mind regarding the security of their personal information. They can improve the procedures for insurance trials and provide simple access to data from many institutions.

Digital contracts make it simple to track system efficiency and monitor patient interactions in real-time. Productivity can be increased by integrating smart contracts with reputable medical practice management systems.

Specific areas where the healthcare industry benefits from a smart contract are as follows:

Health Insurance: Reduces inefficiencies in the current system by automatically adding patient information to policy forms, removing middlemen, and guarding against database hacks.

Electronic Medical Records (EMR): Once the multi-signature approval is obtained between the patients and providers, the EMR will enable the transfer or access to the patient's health record.

Medical Research: By paying patients small amounts of money for their participation, researchers can access the users' health data.

Track Health: Patients can track health-related events using various IoT devices, and rewards are given out when they reach certain milestones.

Real Estate Industry

Companies in the real estate sector can use smart contracts to execute agreements between buyers and sellers, tenants and owners, and so on.  

Propy, an online real estate marketplace, is only one of the several applications for smart contracts. With its unmatched fairness and legality, the system makes it simple for buyers to search for and make purchases.

The best real estate management software systems available today should be integrated with digital contracts to increase efficiency further.

Supply Chain

In supply chain, negotiations are typical. It would gain enormous benefits from implementing smart contracts. Smart contracts can be used by supplier and logistics companies to reduce risks and automate billing and product release procedures.

Financial Services

When it comes to the financial business, the use of smart contracts transforms traditional services in a variety of ways, including:

When the trade settlement amounts have been determined, you can transfer funds and handle the counterparties' approval workflow.

Insurance Claim: This function performs routing, error checking, and the approval workflow; if these tasks are completed successfully, it transmits payment to the user after calculating the payout based on the kind of claim and the underlying policy.

Micro-insurance: Utilizing consumption information gathered from Internet of Things (IoT) enabled devices, micro-insurance calculates and transfers micropayments.

Micro-lending: With the help of microlending, you are given the ability to audit the value of the primary collateral and safely keep it in a database, making each transaction swift, reliable, and visible.

Transparent auditing:

  • Integrates essential bookkeeping tools.
  • Removes the possibility of hacking into accounting records.
  • Enables transparent stakeholder participation in decision-making.

Limitations of Smart Contracts

It may be true that smart contracts come with a few benefits and are making their mark in different industries, but just like any other disruptive technology, they have their limitations.

Vague Terms

There are several unwritten, implicit terms and conditions that makeup contracts. Generally speaking, smart contracts fall short of the appropriate mode if you intend to introduce an event.

Even though it is relatively simple for a smart contract to handle a transaction where only a small number of parties are involved, the possibility they must perform is fairly direct.

Potential for Loopholes

Generally, the idea of good faith implies that both parties will treat each other fairly and refrain from obtaining unethical benefits from a contract. However, when using smart contracts, it is challenging to guarantee that the terms are followed.

Third-party Participation

It is impossible to remove third parties from smart contracts even though they aim to do so. Third parties take on new responsibilities in contrast to the roles they played in conventional contracts.

For instance, attorneys won't be required to draft individual contracts, but developers will still need them to comprehend the conditions when writing the programs for smart contracts.

Difficult to Change

It is nearly impossible to change how a smart contract works, and fixing a code fault can be time-consuming and expensive.

Final Thoughts on Smart Contracts

Unquestionably, smart requirements-powered contracts are the way of the future for relatively simple contracts that can be written and executed automatically whenever prerequisites are satisfied, like in residential conveyancing, where completion funds can be disbursed as soon as contracts are signed.

Different smart contract platforms will revolutionize how companies engage with their customers and in the supply chain while saving them time and money worldwide. Minimal human intervention will liberate people and key decision-makers from dealing with tedious administration and red tape, allowing them to concentrate on their day jobs. It is a result of the smart contract picking up the slack.

Numerous banks and insurance companies currently employ smart contracts in their regular operations. Since they are already in use and being tested in actual situations, it’s only a  matter of time before smart contracts become a regular part of our daily lives.

Smart Contracts in Blockchain [Infographic]

Smart Contracts in Blockchain [Infographic]

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