What Is a Smart Contract in Crypto? How They Work & Use Cases

What Is a Smart Contract?

A smart contract is a digital agreement stored and executed on a blockchain network. These contracts are programmed to perform specific actions once predefined conditions trigger them, ensuring reliability and efficiency. 

Smart contracts utilize blockchain technology, which are designed to enhance immutability and authentication. Once created, the contract is tamper-proof, offering unparalleled security. Whether for managing digital assets, automating payments, or powering decentralized applications (DApps), smart contracts are reshaping how agreements are made.

Ethereum: The First Mover

The idea of smart contracts actually predates blockchain and cryptocurrency, and was first proposed by developer Nick Szabo, a computer scientist who linked them to vending machines, in 1994. Although the launch of Bitcoin in 2009 made smart contracts a technical reality, it was the Ethereum protocol that elevated the tech to a foundational element of blockchain.

While simple smart contracts — like multi-signature wallets —  are possible on Bitcoin, the more versatile and complex smart contracts widely discussed today are primarily found in Ethereum’s fast-proliferating ecosystem of dApps that make up the decentralized finance (DeFi) ecosystem. Concurrently, many other projects are building Layer-2 solutions to improve Ethereum’s capacity for execution of smart contracts. These projects are adding features such as increased throughput, lower transaction costs, and privacy enhancements. There are also several blockchains such as Cardano, EOS, and Chainlink that are assertively expanding smart contract use cases and market share, and further developing the technology.

How Do Smart Contracts Work?

Smart contracts operate on blockchain technology and are self-executing programs running on a blockchain network. They follow a simple if/then logic: when specific conditions are completed, the contract executes predefined actions automatically. 

Here’s a breakdown of how they work:

Programming the Contract

Smart contracts are written using a programming language like solidity, designed for the Ethereum blockchain. Developers encode the contract’s terms into a series of instructions.

Deployment on the Blockchain

Once the contract is written, it is deployed onto the blockchain. The contract becomes immutable at this point — it cannot be altered, ensuring trust and transparency.

Contract Execution by Nodes

When the required conditions are met, the smart contract automatically executes. For instance, a rental payment contract could release funds to the landlord’s wallet as soon as the tenant transfers cryptocurrency.

Validation via the Ethereum Virtual Machine (EVM)

On platforms like Ethereum, the Ethereum Virtual Machine (EVM) validates the execution of the contract across decentralized nodes in the network. This ensures that the contract runs exactly as intended.

Payment of Gas Fees

Every operation in the contract requires computational resources, which are paid with gas fees in Ethereum’s native token (ETH).

Real-World Example

Imagine a company using a smart contract for a supply chain. When goods are delivered, the blockchain verifies the receipt and releases payment automatically to the supplier. There’s no need for middlemen, saving time and ensuring accuracy. 

Smart contracts rely on blockchain’s distributed ledger technology, offering a new level of security, automation, and immutability. 

Why Are Smart Contracts Superior to Traditional Contracts?

Smart contracts provide a blockchain-based alternative to traditional agreements, addressing inefficiencies, high costs, and geographic limitations. 

Here’s how they outperform conventional contracts:

1. Automation and Cost Savings

Smart contracts automatically execute terms via self-executing code, removing the need for intermediaries. On the other hand, traditional contracts require manual oversight, leading to delays and higher costs.

In DeFi, smart contracts streamline lending, reducing operational expenses.

2. Transparency and Fraud Prevention

Smart contracts are stored on an immutable blockchain system, ensuring transparent and tamper-proof terms.

Traditional contracts depend on trust, making them prone to fraud or disputes. For real estate, smart contracts guarantee seamless and secure ownership transfers.

3. Instant Execution 

Smart contracts execute instantly when conditions are met, powered by blockchain networks like Ethereum. Traditional contracts require lengthy negotiations and back-and-forth communication. The speed of smart contracts is invaluable in NFT marketplaces, ensuring creators are paid immediately.

4. Security and Reliability

Smart contracts offer unmatched security, being immutable and resistant to tampering. Traditional contracts, however, can be altered or challenged without strong legal safeguards.

Proper security is essential for managing digital assets in crypto transactions.

5. Global Reach 

Smart contracts enable cross-border agreements without jurisdictional constraints — conversely, traditional contracts are limited by local laws and processes.

In supply chain management, this global accessibility ensures seamless cross-border operations.

When Are Smart Legal Contracts Used?

Smart legal contracts combine the efficiency of blockchain-based smart contracts with the enforceability of traditional agreements. This fusion bridges the gap between emerging crypto solutions and established legal frameworks, making blockchain technology relevant in regulated industries. 

Ensuring the Crypto Connection

Nevertheless, even in these legal settings, the part of the cryptocurrency is crucial. It is strictly compliant, transparent, and trackable when trading in digital assets. 

For instance:

• In real estate, crypto can be calculated for a certain number of payments within a contract. 

• In financial agreements, blockchain guarantees that the issuance of a loan or payment under an insurance policy is immediate and uncontaminated by human interference.

Smart contracts, integrated with blockchain technology into the legal space, achieve the necessary synergy between decentralized tools and enforcement mechanisms.

What Are Some Use Cases for Smart Contracts?

Smart contracts are transforming industries since they use blockchain technology to automate, increase transparency, and save money. 

Let’s explore how they are transforming key sectors in the crypto ecosystem:

Finance and DeFi

Smart contracts automate lending, staking, and trading, reducing reliance on traditional banks. This enables fast, transparent, peer-to-peer transactions, reducing costs and increasing financial service access. 

For example, DeFi platforms had over $94 billion in total value locked by the end of 2021.

Supply Chain Management

By tracking goods on blockchain-based systems, smart contracts ensure transparency at every supply chain stage. They reduce fraud, automate payments, and provide accurate, immutable records for all stakeholders. Implementing blockchain in supply chains may reduce delays and disputes by over 50%.

Real Estate

Smart contacts streamline property transactions by automating ownership transfers and payments, reducing the need for intermediaries like brokers. This results in time and cost savings. Some property transactions have been completed in minutes instead of weeks using blockchain technology. 

Healthcare

Smart contracts protect patient data in healthcare by ensuring secure and private record-sharing. They automate insurance claims and other administrative processes, improving efficiency while maintaining trust through blockchain authentication. This leads to faster processing times and reduced administrative costs.

Non-Fungible Tokens (NFTs) and Digital Assets 

This rise of NFTs relies on smart contracts to manage ownership, automate royalties, and secure sales. Blockchain ensures transparency and trust, making NFTs a cornerstone of the crypto ecosystem. In 2021, the NFT market surpassed $17 billion in trading volume.

What Are Some of the Limitations of Smart Contracts?

Despite their promise, smart contracts face some challenges:

1. Coding Errors: solely within the contracts lie; defects in the smart contract code can result in expensive weaknesses that hackers exploit.

1. Legal and Regulatory Issues: Smart contracts are more than traditional contracts since they maybe legally enforceable in all countries.

1. Immutability: On the other hand, immutability makes tamper-proof transactions, and any mistakes made while creating the transactions will require considerable effort to reverse.

The Bottom Line

Smart contracts are paving the future with more efficient, secure, and open industry structures. Whether decentralized finance, real estate, healthcare, or non-fungible tokens (NFTs), they remove middlemen, cut expenses, and facilitate borderless transactions using blockchain.

At Gemini, we’re here to help you confidently navigate the world of crypto. Gemini offers tools to explore the fundamentals of smart contracts and leverage its blockchain platform to securely stake and manage digital assets.

We aim to make it easy for users to understand the possibilities of crypto. Check out the rest of our Cryptopedia for more information, and get started on the path toward the decentralized future with Gemini staking.