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A smart contract is a program running on a blockchain that automatically executes an outcome when certain predetermined conditions are met.
Smart contracts are commonly used to automate the implementation of an agreement so that all the parties are aware of the action without any third-party involvement.
In technical terms, smart contracts can be described as computer code running on a blockchain that automatically executes a portion or the entirety of an agreement. The code can either be an agreement between the participants or complement a traditional contract and implement specific provisions. For instance, transferring funds from one party (A) to another party (B).
Smart contracts share the same features a blockchain offers, such as immutability and transparency, with the code replicated across multiple nodes in the chain. With each new block added to the chain, the smart contract is also in effect and executed.
Therefore, if transacting parties have indicated specific parameters have been fulfilled, the code will execute the action based on those parameters. On the flip side, the code will remain inactive if no transaction has been initiated.
Smart contracts operate by following input parameters that are written into a code on a blockchain. If condition ‘X’ happens, execute action ‘Y.’
At the moment, the tasks being performed by smart contracts are basic, such as releasing funds from an escrow or reserve once the transacting parties meet certain conditions.
Currently, smart contracts are being used to execute two types of transactions automatically:
01 Ensuring funds are released when certain events are triggered.
02 Acting as an enforcement tool by imposing financial penalties if certain objective conditions are not fulfilled.
In the former case, the smart contract has replaced the need for a human acting as a trusted escrow. In the latter case, no judicial enforcer is required to impose penalties. In both scenarios, the smart contract reduces the administrative costs associated with execution and enforcement.
Proponents of blockchain-powered automation argue that in the future, more transaction steps will be written into code to enable smart contracts to determine legal criteria.
Smart contracts can accommodate as many process stipulations as are needed to satisfy all parties that the task will be completed satisfactorily. For this to happen, the participants must determine how transactions and data are represented in the blockchain network.
Moreover, they must agree on the ‘if, then, and when logic that will govern the transactions, handle all the exceptions and define a dispute resolution mechanism.
On most blockchains, before traders can execute a compiled smart contract, traders need to pay a transaction fee for the contract to be added on-chain and completed. For instance, the Ethereum network requires “gas” fees when executing smart contracts.
The more complex the transaction steps, the higher the gas fees needed to execute the smart contract. Gas fees are a helpful moderator to prevent complex or many smart contracts from overwhelming the network.
