You don’t have to be shy, we all were new to this crypto-world and didn’t know or understand all of the terminology right off the bat. Many people trade Ethereum on a daily basis and don’t fully know what a ‘smart contract’ is. Let’s help you out with this!
The term smart contract is a bit tricky to understand because the term has been known to confuse people when it comes to the core interaction described.
So everyone is aware of a standard contract, a contract that outlines very specific terms of a relationship, and it is usually enforceable by law. A smart contract sort of does the same thing except it doesn’t enforce the relationship by law, it does it with cryptographic code.
Put into simpler terms, smart contracts are programs that operate exactly as they were designed by their creators/developers.
Let’s clarify further with an example. Ethereum owners can send 5 ether to a friend on a specific date leveraging a smart contract. In this scenario, the owner of the ether would create a smart contract, then push the terms (or the data) to that contract so that it can execute the desired command created.
Ethereum is a platform that was built exclusively for the purpose of building smart contracts.
But don’t get it twisted… these new tools were never intended to just be used in isolation. It is believed by most that the greater dream was for them to be leveraged to form the building blocks for DAPPs (decentralized applications) and even DAOs (decentralized autonomous companies/organizations).
How a smart contract works
When anyone in the crypto industry hear the term smart contract thrown around they immediately associate it with the Ethereum blockchain. But it is worth noting that bitcoin was, in all honesty, the first network to fully support basic smart contracts. What we mean is, the bitcoin network was the very first environment that made it possible to transfer value from one person to another person. On this network, a transaction can only be validated if very specific conditions are fully met. There is no grey area on the completion of the set conditions. It’s either the conditions are met or they are not.
But the difference between the Bitcoin blockchain and the Ethereum blockchain is the fact that Bitcoin is limited to the currency use case. Ethereum virtually has unlimited potential for its use.
Another way Ethereum separated itself from bitcoin is by moving away from such a restrictive language environment (Bitcoin is made up of a scripting language of about one hundred scripts). Ethereum replaces that language with one that allows any developer to write their own programs on the network.
Smart contracts are able to:
- Manage any sort of agreements between users.
- Operate as ‘multi-signature’ accounts. A security measure that will only spend funds once a required percentage of people are in agreement.
- Offer utility to other contracts (sort of how a software library works if you are familiar with that concept)
- Safely store information and data about an application.
The strength is in the numbers
Taking that last bullet point a bit further, smart contracts are more than likely to need assistance from other smart contracts in the network.
Let’s say someone places a bet on the temperature on a cold winter day, it might end up triggering a series of contracts under the Ethereum hood.
One contract would be leveraged to use outside data in order to determine the weather on that cold day and another contract could possibly settle the terms of the bet based on the information it received from the original contract once those conditions are met. So one contract feeds into another.
When you run each of those contracts that action requires ether transaction fees, which all depend on the amount of computer power required to execute the requests.
Smart contracts on the Ethereum network can only be ran once a user or another smart contract sends it a message with enough transactions fees to cover the request. Then the smart contract is executed in ‘bytecode’, or a binary series of ones and zeroes that can only be understood by the Ethereum network.