HomeCrypto blogHow does Smart Contracts Work | Smart contracts Explained

How does Smart Contracts Work | Smart contracts Explained

How does Smart Contracts work? What if I told you that you could borrow 20 million dollars without any down payment? Yes, you heard that right, and would you believe it, If I say you can instantly buy and sell a house without going through the hectic week of advertising, securing funds, insurance, and closing, or how about I tell you that you can create an entire insurance company with some code.

By this point, I am sure it sounds crazy but this is where the power of smart contracts comes into the frame. With just a simple code smart contracts can make all of these a reality.

What are Smart Contracts in blockchain?

Basically, a smart contract is just a piece of code. The contents of the buyer-seller agreements are inscribed in the code. Using solidity we can write many smart contracts on Ethereum networks. This piece of code running on the blockchain is executed if something else happens. They are self-executing contracts and make them hassle-free to use. Let’s think about a situation where smart contracts are actually used.

Smart Contract Use Cases

How does Smart Contracts work Example, At the airport, Rachel is waiting for her delayed flight, and the insurance provider Axa uses Ethereum smart contracts to offer flight delay insurance, In such a scenario Rachel is compensated by this insurance How? The database that tracks flight status is connected to the smart contract. The terms and conditions are used to create the smart contract. A delay of two hours or more must occur in order for the insurance policy to be in effect.

Ethereum Explained
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The smart contract keeps Axa’s funds until that particular condition is satisfied. According to the code, the smart contract is sent to the EVM nodes for review but the runtime compiler executes the smart contract code. The code must produce the same output on every node in the network that is running it. The distributed ledger includes that outcome. The smart contract soft executes and pace ratio if the flight is delayed for longer than two hours, due to the immutability of smart contracts no one may change the agreement.

The code can be as simple as if you give me 10 Ethereum I will give you 30 basic attention tokens in return if I get 10,000 subscribers this year. In simple words the phrase this then truly defines the functioning of smart contracts. Here if this is when you get 10,000 subscribers and then that is giving 30 basic attention tokens and this is the best part of smart contracts. It allows token switching, which is a roller coaster for all-day traders or investors.

Suppose you wish to buy a coin that is not available on a significant platform like Coinbase what you can do is buy the ones that are available and swap them later on decentralized exchanges for the tokens you want.

Smart contracts are most widely used in creating liquidity pools. Here pools of money are created which allows a trader to switch from one token to another.

The liquidity pool starts with a ratio of 50-50. So if you are trading one Ethereum for basic attention tokens the volume of Ethereum’s buy to the pool increases, which hikes the price of basic attention tokens. This is just a brief of how liquidity pool works and if you’re curious to dive deep into this you can check out our recent article on liquidity pools that guide will give more clarity.

We can also write a contract where to research an address people could generate Ethereum and in return, after it reaches the target say 1,000 Ethereum we can give them NFTs or invite them to join a community. 

Purpose of smart contracts

Why Smart Contracts was created? How does Smart Contracts work? There are endless applications of smart contracts but amongst all of them, two features make it stand out.

Number one smart contracts are immutable, like I said smart contracts get triggered when the condition is met so these cannot be changed. Changing the code is out of the box since it’s on the blockchain. This can be inefficient in case there are any bugs, but on the downside, the problem can be solved by creating a new smart contract and all you have to do is just give prior information asking people not to use the previous one. It might sound gruesome but this happens often and it’s easy.

Number two no discrepancies if and when certain conditions have been met the agreement drafted between a few online parties is to be executed. Knowing these nuances you can claim that it was an informal agreement in such an allegation hiring a lawyer is entirely vain. There is no room for discrepancies since these smart contracts are accessible to anyone anywhere in the world just because it’s a bunch of computer code you can’t argue that it’s not an agreement. Now you might think these are all the downsides of this technology but you’d be baffled by the power it holds in the present world. 

Benefits of Smart contracts

Number one is accuracy, speed, and efficiency. Since whenever a condition is met the contract is executed. This saves a lot of time since it’s automated. This is completely digitized and efficient. The old-school process of paperwork is not needed choosing this would be a wise option since it’s the best alternative to eliminate human errors.

Number two trust and transparency. Since no third party is involved and participants share encrypted transaction logs there is no need to worry about data being altered for personal advantage.

Number three security blockchain transaction records are exceedingly hard to attack since they are encrypted. Additionally, hackers would need to alter the entire chain in order to alter a single record on a distributed ledger, because each entry is connected to the entries that came before and after it.

Permissioned vs Permissionless Blockchain Networks
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Number 4 savings, So what is more valuable time or money if you think it’s money Naval Rabicott says “you’re spending time to save money when you should be spending money to save time” but smart contracts save both time and money. This is why many organizations are now heading towards using blockchain for business. The structuring of smart contracts can now be done seamlessly thanks to the development of standard web interfaces and other online tools like templates, which also have the peculiar property of automating execution in a split second. So now all the users can know the outcome as soon as possible. In other words, smart contracts do away with the need for transaction intermediaries. 

Questions about Smart Contracts

How does Smart Contracts work? Like I said it is very much possible to borrow 15 million dollars with no down payment this process is known as a flash loan. This holds immense power because you can borrow millions to get your work done and pay it back using smart contracts. You just have to know how to code to do this in the Ethereum network. 

Now you might be baffled hearing why in the hell you would pay back millions instantly in the first place. So here’s the catch let’s take the example of dogecoin. Suppose let’s say dogecoin is trading at 0.70 on Binance and 0.80 on Coinbase. You can literally buy dogecoin and Binance and sell them on Coinbase. Theoretically, you can book a huge profit if you can invest millions in doing so. Suppose you borrow 20 million dollars to buy tons of dodge coins on Binance and sell it on Coinbase after this you can pay back the loan amount. You can earn big bucks in the form of profit and your only cost would be the little interest you pay on the loan amount and all of this process is automatically done by the smart contract. It will help the borrowing and paying back the loan.

Now if you get practical for a minute this would be almost impossible to execute in a traditional market, but in blockchain smart contracts can make it possible, that’s the kicker in smart contracts.

Related: What is a DAO? Decentralized Autonomous Organization Explained

We think it was super helpful for you to understand this topic anyway, this is only for informative purposes remember it is not any financial advice so we recommend you do your own research.



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