How Do Ethereum Smart Contracts Work?

There are a few subjects in cryptocurrency which are prone to misunderstanding. The smart contracts that are a major part of the Ethereum platform are one such subject. As a crypto investor you have probably heard about them but have little insight into how they work. Here’s a brief overview of smart contracts and some of their applications on the Ethereum blockchain.

The Basics of Ethereum Smart Contracts

It’s true. The concept of smart contracts as laid out by Ethereum is a little hard to understand. The problem is one of semantics and the knowledge most people have about traditional contractual agreements between two parties.

A contract as most people know it is an instrument that is subject to legal enforcement. It specifically defines an agreement between two parties. Smart contracts are different because they rely upon cryptographic code to make sure the terms of the contract are upheld by the parties involved.

Once a smart contract is created on the Ethereum blockchain, there is no need for third-party oversight to make sure the contract terms are honored. To be more direct, a smart contract is a piece of code that will execute precisely what the parties involved want to accomplish. It does this autonomously.

The idea behind a smart contract is actually much older than blockchains and cryptocurrency. It was first advanced in 1993, back when the Internet was in its infancy. The person behind the original idea was Nick Szabo, a pioneer of cryptography.

The concept of a vending machine was famously how Szabo described his idea. He envisioned a platform that would allow users to select something such as a soda or a snack from a vending machine. The machine would be capable of collecting payment, dispensing the item, and even reordering inventory to keep the machine full. All this could be done without the need of human involvement. Autonomy is at the heart of all smart contract applications.

Here is the important thing that you need to know. The Ethereum platform is different from most major cryptocurrencies for a very important reason. It was built with smart contracts in mind. Dapps and DAOs are other terms that the user of Ethereum should become familiar with, and both of these sort of branch off the root foundation of smart contracts.

How Smart Contracts Work

The use case of smart contracts is what most people are concerned with when it comes to Ethereum, aside from Ether as a cryptocurrency. Bitcoin was actually envisioned as a cryptocurrency that worked on a type of smart contract platform. Through the use of nodes and the blockchain, users could exchange crypto for things of value. The transaction would then automatically be added to the blockchain through the network of nodes. It is only possible for a node to add blocks to the blockchain when certain conditions are met.

The thing about Bitcoin is that its functionality in this regard is limited to only transfers of cryptocurrency. Ethereum took it a step farther by making it possible to use smart contracts for a variety of purposes. These include:

  • Creating multi-signature accounts
  • Managing user agreements
  • Adding utilities to other contracts, like a library of software plug-ins
  • Storing multiple types of information and records

In order for a smart contract to work on the network, there is a “gas” required to pay for transaction fees. With Ethereum, this gas is known as Ether. Ether is the actual physical token that is used with the Ethereum platform.

It is ultimately the execution of code which enables smart contracts to function as intended. A great thing about Ethereum is that it actively encourages individuals to develop their own code and smart contracts.

Once the code has been created, the smart contract allows for actions to be completed without the need for a third-party involvement. When conditions defined by the smart contract are met, the contract is autonomously fulfilled.

Ethereum has certainly captured the hearts and minds of those who appreciate the technology behind cryptocurrencies. It is a platform that offers vast potential, and more development will be good for the value of Ether and other tokens.

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