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Smart contracts often generate a certain level of confusion. Coming from different perspectives, people define them in different ways, thus causing misunderstandings of the term within the context of what they can do for businesses. Some of the haze ensues from common definitions that don’t draw a clear distinction between legal contracts and smart contracts.

Smart Contracts vs. Legal Contracts

Though smart contract services can replace some aspects of contractual law, they are definitely not a legal concept. They do support business transactions, but more in the sense of a technical solution for the digital realm in which companies search for new ways to make their projects more profitable. Smart contracts work by delegating certain transaction elements to the computer by giving it instructions with cryptographic code.

Smart contracts are a piece of code, which blockchain developers implant in decentralized networks. They work under a set of predefined, self-executable, known-to-all-parties rules.

Smart contract services simplify many of the processes that need to be otherwise completed or verified by humans, by transferring them to a computer. In this sense, a smart contract can be a reliable auditor.

Types of Smart Contracts

Bitcoin can be considered the first smart contract in the sense of current blockchain technology. However, the cryptocurrency is a fairly limited representative of the concept, as it doesn’t depict all ways in which smart contract services work. Bitcoin is a smart contract executed on a fully decentralized network, without the interference of intermediaries or third-party fees.  

The Ethereum platform, in contrast, is not simply finance-based. Its Solidity development projects extend to business solutions. On Ethereum, developers create an open-source code to apply decentralized technologies in areas such as digital identity, voting, utilities and computing resources, to name a few.

Smart contracts can be applied to closed organizations. The Hyperledger project, for example, develops blockchain projects where decentralized networks are available only to specific participants who can join the group by invitation. Hyperledger is not fully public; businesses need to gain permission to be accepted in the inner circle. The difference between the Hyperledger projects and a 100 percent decentralized blockchain is in the business logic. It’s more viable and efficient to create a closed platform for organizations that meet the integrity and trust criteria than to give every member of the public the same level of trust.

How Do Smart Contracts Work?

If you are considering smart contract services, a blockchain developer can create a contract that sets a range of criteria to validate multiple transactions. Transactions will not be limited to a simple give-and-take exchange of value. They can also include dates, qualities or quantities, and other specifications that must be met if the transaction is to be considered valid. The event takes place only after all conditions have been met by all transactional parties.

The instructions are embedded within the code and are impossible to change unless all parties agree to update the smart contract. For instance, a second stage of the transaction can’t take place until the first one is completed. A typical example of a smart contract is a group signature, where a business transaction is valid only after a certain number of people have signed.

With smart contracts, businesses can gain a new level of protection against unknown outcomes. Because the records in a decentralized ledger are permanent, immutable and traceable, it’s virtually impossible to get an outcome that wasn’t planned by the parties.

Smart contract services have proven to be an effective solution for supply chain management. Each participant in a supply chain built on a decentralized blockchain has insight and access to the recorded transactions and can keep track of what happened at a certain point in time or location.

Immutability, permanency, and consensus are three important aspects of smart contracts that protect participants from unscrupulous activity. However, smart contracts are still executed on a computer network and are therefore vulnerable to mistakes made during their processing. Despite their imperfections, smart contracts can potentially help you develop new business solutions, such as avoiding multiple transaction fees, letting computers run secure transaction records, verifying recorded data, and even creating your own cryptocurrency.

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Disclaimer: This article should not be taken as, and is not intended to provide, investment advice. Global Coin Report and/or its affiliates, employees, writers, and subcontractors are cryptocurrency investors and from time to time may or may not have holdings in some of the coins or tokens they cover. Please conduct your own thorough research before investing in any cryptocurrency and read our full disclaimer.

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