Introduction
Blockchain technology has introduced us to several new concepts that have completely changed the way we function. One of these concepts is smart contracts. Thanks to them, the need for a middleman or intermediary during transactions has been eliminated. Though blockchain technology has several problems, it is still faster, more secure, and cheaper than currently used systems.
A smart contract is a self-executing computer program containing information that automatically enforces the agreement. It has become the most critical component of several decentralized applications and blockchains today.
What Is a Smart Contract?
Let’s look at them in a slightly more detailed manner. What exactly is a smart contract? It is an agreement between two parties that is written in the form of code. They run on the blockchain and are stored on a public ledger that ensures no one can manipulate them.
A smart contract works like a regular contract, allowing two parties to exchange anything valuable (money) transparently and securely. However, there is one significant difference between standard contracts and smart contracts. The latter has eliminated the need for a middleman in transactions.
Smart contracts are essentially lines of code that are stored on the blockchain. The smart contract contains the terms on an agreement, automatically verifies the contract, and automatically executes it once the predefined conditions are met.
In normal circumstances, agreements between parties would require a third party or an intermediary. Smart contracts let you cut out these middlemen. They do more than define the terms of an agreement; they also enforce the terms of the agreement.
To understand this concept, let’s look at a very popular example. We can compare the technology behind smart contracts to a vending machine.
If you want to get a particular document, you must go through a third party and wait while the document is procured for you. However, a smart contract will allow you to drop cryptocurrency (bitcoin) into the vending machine (the ledger), and your documents are directly dropped into your account.
Who Created Smart Contracts?
They were created by Nick Szabo, a computer scientist, scholar, and cryptographer. Szabo was also the person that invented Bit Gold in 1998, a full ten years before Bitcoin. There are also rumours that Nick Szabo is Satoshi Nakamoto, rumours that he vehemently denies.
Szabo realized people could use smart contracts on a public ledger. Coders could convert the contracts into code stored on the system under the supervision of the computers running the blockchain. He described them as transaction protocols that automatically execute a contract when specific predefined terms are met.
Szabo proposed a contract for synthetic assets; according to Szabo,
“These new securities are formed by combining securities (such as bonds) and derivatives (options and futures) in a wide variety of ways. Very complex term structures for payments can now be built into standardized contracts and traded with low transaction costs, due to computerized analysis of these complex term structures.”
If we look at Szabo’s predictions today, we see that most of his predictions came true even before the advent of the technology behind blockchain.
How Are Smart Contracts Created?
You can create them on several blockchains such as Ethereum, EOS, NEO, etc. However, Ethereum is the most popular blockchain when it comes to smart contracts. Because of the popularity of the blockchain, they are written in Solidity. Solidity is Ethereum’s original coding language.
How Do Smart Contracts Function?
Let’s look at an example to understand how they work. Person A wants to buy a product from Person B and pay Person B by using cryptocurrency and the blockchain network. Person A will get a receipt once the payment is made, and this receipt is included in the contract. Once Person B gives the product to Person A within the specified period, Person A will release the payment.
However, if Person B hasn’t ensured that the product has been received by Person A within the specified time, the blockchain network automatically calls for a refund. However, if Person B gives the product within the specified time, the contract will hold both the product and payment until the date defined in the contract.
This system is almost impossible to breach as the parties involved know what is going on at all times. In addition, the system and transaction are witnessed by others on the network, ensuring complete transparency.
What Makes Smart Contracts Desirable?
- Smart contracts are free of interruptions. This is because the contract eliminates any third-party involvement, leaving you in complete control and without having to wait for confirmation from third parties.
- They offer better security, keeping data and other information safe from being compromised.
- Smart contracts work faster than physically processing documents. This is because they execute the contract automatically, thanks to blockchain technology. This saves a lot of time when it comes to enforcing contracts.
- They ensure that there are no errors while executing the contracts. A complete record of the contract will be stored to ensure that the execution of the contract is error-free.
What Are the Uses of Smart Contracts?
Individuals or organizations can use them for several services like legal services, credit authorization, financial services, etc. First, let’s look at some ways they are being utilized.
Banking
Smart contracts have found significant uses in the banking sector and are quickly replacing traditional methods of transactions. For example, banks can use them to automate loan disbursals, payments, and pretty much any other financial transaction.
In addition, KYC-Chain utilizes smart contracts for businesses and major financial institutions, helping clients comply with regulatory frameworks and norms.
Government
Smart contracts could ensure a secure voting system. Votes would need to be decoded and would require considerable computing power to access. They could also help increase voter turnout, as a smart contract could be implemented to save voters from cumbersome activities like lining up to vote, proving your identity, and filling endless forms.
Trading
Traditional trading activities require the presence of an intermediary, making trading a costly affair. Smart contracts can cut out the middleman from all trading activities, making trading more straightforward, cost-effective, and efficient for all parties involved.
Mortgage
Smart contracts have also found utility in the mortgage space. Mortgages and mortgage agreements are notoriously complicated, with essential information flowing between both parties involved.
In addition, data such as earnings, expenditures, and credit make mortgages complex and costly. With smart contract technology, all processes involved in mortgages would be automated, eliminating unnecessary steps and intermediaries.
Real Estate
Smart contracts also cut out the middleman from real estate transactions. Before the advent of these contracts, sellers had to advertise on third-party platforms while also enlisting the help of brokers to sell or lease their properties.
Using a smart contract and the public ledger, all the seller has to do is feed the information about the property, owner, and buyer in the agreement. The contract then checks if the information is genuine, initiates the payment, and completes the transfer of the property.
Healthcare
The healthcare system also utilizes smart contracts to streamline its records. The use of blockchain technology enables hospitals to maintain a large amount of data. For example, all personal records of patients would be stored on the blockchain, accessible only through a private key, which will be kept only with specific individuals.
Peer-to-Peer Transactions
Peer-to-Peer transactions can use smart contracts; users on P2P networks can create contracts and specify the terms of the agreements. The contract remains active until a set of predefined conditions are met.
Once the requirements are met, the contract executes automatically. Thus, Peer-to-Peer contracts have endless possibilities and have extensive use cases in P2P transactions.
Insurance
An insurance company can utilize smart contracts to improve the claims process. This would allow them to determine payouts based on the type of policy an individual or organization held.
Information such as driving records, driver’s license information and policy details could be processed quickly, ensuring a quick payout of the claim.
Trade Finance
Trade Finance is one field that is set to benefit from the introduction of smart contracts. A report by Santander InnoVentures has concluded that the use of contracts will enable the industry to save $20 billion per year by the end of 2022. The savings will be made possible thanks to the automation of approvals and calculations.
How Do Smart Contracts Fit in the DeFi Ecosystem?
DeFi has a significant reliance on these contracts, with almost all applications in the DeFi space using them in some way or the other. How do they fit into DeFi? DeFi platforms use smart contracts to define the partnership between them, which allows contracts to be enforced quickly. Since the contracts are written in code, they are executed automatically, cutting out the need to monitor them manually.
The use of smart contracts has made DeFi relatively risk-free for all involved. However, the code used in them could be vulnerable to bugs or glitches. Thus, despite all its benefits, they are not entirely risk-free.
Smart Contracts and NFTs
NFTs or non-fungible tokens are digital tokens based on the Ethereum blockchain, an open-source, peer-to-peer, decentralized blockchain. Ethereum is the second-largest cryptocurrency by market capitalization, second only to bitcoin. Anyone that contributes to its blockchain keeps a virtual copy of the Ethereum Virtual Machine (EVM).
Now that we have an understanding of the Ethereum blockchain, let us return to NFTs. NFTs are also smart contracts, usually ERC-721 or ERC-1155. The first NFT and ERC-721 smart contract was CryptoPunks.
Smart Contracts and Decentralized Applications (dApps)
Decentralized applications, or dApps, are essentially software that communicates with the blockchain. dApps don’t always run on a blockchain network, with several examples of a dApp running on a P2P network. They are integral to the blockchain ecosystem and are considered the backbone of blockchains. They process information and help the blockchain manage the state of all participants of the network.
Smart contracts are part of the core of dApps, running on a decentralized distribution system. dApps are connected to the blockchain through smart contracts instead of being connected to a single centralized data server.
Smart Contracts and Bitcoin
Although Bitcoin is not known for supporting smart contracts, things are changing. Bitcoin has firmly established itself as a store of value. However, can bitcoin also support them? The answer is yes. Several new developments are happening on the Lightning Network. Applications like Stacks and Proof Transfer are leveraging bitcoin’s liquidity for Web 3.0 and smart contracts.
What Are the Benefits of Smart Contracts?
Autonomy
A smart contract gives you complete autonomy over the agreement. There is no involvement of an intermediary or third party. This also prevents any manipulation that could occur if there was an intermediary involved in the transaction.
Trust
Since all your documents and information are encrypted and stored on a shared public ledger, they are always accessible whenever needed and immune to modification.
Safety
Thanks to cryptography and encryption, all your data is safe from any malicious actors.
Savings
Smart contracts automate all aspects of an agreement, from defining the terms to the execution. This helps eliminate several steps when preparing a physical contract. In addition, cutting out additional steps helps save money.
What Are Some Disadvantages of Smart Contracts?
They have several uses and advantages. However, they do have a few disadvantages as well.
Confidentiality
Too much transparency isn’t always a good thing. There are certain aspects of an agreement or a contract that require complete privacy. Unfortunately, Ethereum based contracts do not provide privacy to users.
Human Error
Smart contracts are written and encrypted using code, which could sometimes lead to human error. Sometimes, a coder may make a mistake while writing them, leaving loopholes in the contract.
Unreliable Information
There is a minimal possibility that the information stored initially could be the wrong information, which would make the entire contract and process an error.
Rogue Contract
Since smart contracts execute automatically, if a hacker somehow hacked the system or contract, then it could be programmed to execute malicious instructions automatically.
Which Blockchains Support Smart Contracts?
The first blockchain to allow and utilize smart contracts was Ethereum. Today it is still the go-to blockchain for smart contracts. However, there are several more blockchains that now support them, giving the blockchain considerable competition.
Blockchains like Ripple, Cardano, NEO, Tezos, and even Bitcoin have emerged onto the smart contract scene, becoming somewhat popular alternatives to Ethereum.
Bitcoin
Bitcoin has limited scope when it comes to smart contracts and documents. However, side chains, which run parallel to the main chain, have better scope for processing them.
Ripple
Ripple’s smart contract project called Codius aims to interact with all cryptocurrencies. Codius has the ability to add smart contracts to any cryptocurrency.
Ethereum
Ethereum is the original smart contract platform and remains the most popular blockchain for them, with most of them running on its blockchain. Contracts based on its blockchain have to be paid using the platform’s native currency, Ether.
Tezos
The Tezos blockchain has some unique features, and smart contracts is one of them. Tezos allows its users to create contracts, which can be stored and executed on the blockchain.
Contracts on the Tezos platform are written in Michelson. In addition, it uses formal verification to make them more secure and more dependable.
Cardano
Cardano’s Alonzo upgrade saw the introduction of smart contracts and support for them on the Cardano Blockchain.
Why Are Smart Contracts Important?
Smart contracts have the potential to change how business and trades are conducted entirely. They can speed up the process by introducing automation, speeding up transactions, and reducing paperwork. As a result, several industries like retail, supply chain, telecom, finance, real estate, and more could benefit from them.
Final Thoughts
Smart contracts have unique features that make them very appealing. Many crypto communities feel that they are the future and that whatever flaws they may have can be ironed out with regular use and improvements. Even in their current avatar, they are considered better than traditional methods of drawing up agreements.
Disclaimer: No Investment Advice The contents of this article are for informational purposes only and are not intended as, and shall not be understood or construed as, investment advice, financial advice or trading advice. There are substantial risks associated with the trading of cryptocurrencies and you should consult with a licensed financial advisor prior to making any trading or investment decisions. Content Not Warranted The contents of this article are provided “as is” and without warranties of any kind. You bear all risks associated with the use of the content provided including without limitation, any reliance on the accuracy, completeness or usefulness of any content available within this article.
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