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Introduction 

Can you imagine a transaction where you don’t need a third-party to guarantee trust? This is what understanding smart contracts and how they work teaches you. It was conceived before Blockchain, a distributed ledger technology that enables decentralized, transparent and secure peer-to-peer transactions. However, it seems incomplete without the mention and incorporation of Blockchain. Consequently, we will focus on smart contracts in both the Pre-Blockchain and Post-Blockchain eras.

Before diving in, let’s first define a smart contract. A smart contract is a predefined term or agreement between two or more parties in computer codes. Unlike the traditional negotiation and agreement methods, a smart contract self-executes, according to the terms of the contract. 

For instance, if John and Alice want to transact and sign a smart contract, the contract says “Pay John” when some agreements are reached and “Do not pay” when agreements are not met. Similarly, if Alice does not meet some terms, John should withhold payment and vice versa. A smart contract is a set of computer codes that use if and only if statements to automate transactions in the basic illustration. 

Before Blockchain, there was Smart Contract

Could you imagine that a smart contract came before Blockchain? The same way Blockchain was an answer to distributed ledger technology, so was smart contact. The smart contract started as a stream of thought on how to record contracts in computer codes. By implication, it leverages computer codes to mitigate the risks of third parties or intermediaries.

A smart contract was the idea of Nick Szabo, a computer scientist and cryptographer in 1996. During reworking the concept, he published a book titled; Smart Contracts: Building Blocks for Digital Free Markets. However, the smart contract was only a concept until the invention of Blockchain.

In the Era of Blockchain

The first implementation of Blockchain was Bitcoin, which was created by Satoshi Nakamoto, a Pseudo-anonymous entity or group in 2008. After that came the Ethereum, by a young programmer named Vitalik Buterin.

With Ethereum, Blockchain grew beyond a financial service enabler to a decentralized application. Among other innovations of Ethereum is the Decentralized application, called DApp, smart contracts and so on. Although Ethereum pioneered smart contracts, several Blockchain like NEO, EOS, and others have since adopted smart contracts. However, Ethereum remained a major smart contract enabled Blockchain. 

How Do They Work?

Although the basic understanding of smart contracts portray it as a set of self-regulating computer codes to understand how they work, you must look beyond that. Concurrently, there are several components of smart contracts, including the environment and objects.

Environment

At the beginning of this article, you learned that a smart contract was not implemented until the invention of Blockchain. Therefore, the Blockchain defines the environment.

Blockchain provides a perfect environment for a smart contract. It supports:

1. Public-key cryptography, which enables users to sign off for the transaction using their unique, specially generated cryptographic codes.
2. An open and decentralized database enables trust-less transactions, while allowing users to access the network and interact in a distributed manner. 
3. A reliable source of data; herein, Blockchain uses a distributed ledger technology that allows tamper-proof and transparent transactions in a peer-to-peer system. 

Objects

On the other hand, the object represents the signatories, subject of agreement, and contractual terms. The signatories refer to the contractual parties. The subject is the function of the environment described above, while the contractual terms are the agreements written in codes. 

Simply put, a signatory defines contractual terms on the subject environment. Therefore, the terms self-execute as predefined. For instance, John and Alice are the signatories who wanted to perform a transaction called the subject. Before the transaction, they agree to predefined roes called contractual terms.  

Use Cases

The invention of Ethereum is a wake-up call to the Blockchain application beyond finance. Therefore, the smart contract has a wide range of use cases that include, but are not limited to DeFi, ICO, Flash loans, Yielding, Automated market making, etc. The smart contract enables seamless self-execution of agreements between parties in a peer-to-peer system across several industries including, Energy, Medicine, supply chain, and so on.