● Intermediate Technology

What is a Smart Contract?

10 minutes 2 years ago

What are Smart Contracts on Blockchain?

Smart contracts are digital contracts stored on a blockchain that are automatically executed when predetermined terms and conditions are met. Participants of agreements or contracts can be immediately certain of the outcome, without any intermediary’s involvement or time loss. Just like a traditional contract, a smart contract allows two or more parties to code the conditions of their agreement. The smart contract will administer these without fear or favour, which is why smart contracts are one of the most revolutionary developments running off blockchain technology.

Smart contracts aren’t merely transactional. Today, blockchain developers can build complex applications called Decentralised Applications or DApps using smart contracts.

DApps are decentralised due to the design of blockchain ecosystems such as Ethereum. No central authority is necessary to execute and mediate agreements between parties. No single user controls the DApp, and all the rules are contained in the terms coded in the smart contract.

Decentralised finance(DeFi) is one of the most well-known examples of DApps. For example, decentralised exchanges allow for complex transactions like lending, savings, or insurance without any central oversight. No institution or middle man is required to facilitate transactions on these platforms. DeFi also ensures universal access to financial cryptocurrency services.

Examples of advanced DApps include:

  • Compound is a platform that allows peer-to-peer lending and borrowing. Lenders earn interest on their crypto, and borrowers access funds easily and quickly.
  • USDC is a stablecoin that keeps the value of one coin at the value of one dollar. It is a type of digital currency backed by the value of a fiat currency.
  • CryptoMines is a SciFi game launched on the new Binance Smart Chain (BSC). CryptoMines allows players to explore the Metaverse and earn crypto tokens called ETERNAL.
  • Raydium is a decentralised cryptocurrency exchange (DEX) running on Solana.

How Smart Contracts Work

Despite the name, smart contracts aren’t “smart”. They don’t think on their own, even though they can make real-time decisions. Their autonomy comes from the pre-coded rules and conditions in their functions. In essence, smart contracts work by the simple “If/When …. then …” statements written into code on a blockchain. A network of computers executes the actions when predetermined conditions have been met and verified. Imagine a vending machine that sells cans of soda for a quarter. If you put a dollar into the machine and select a soda, the machine is hardwired to either produce your drink and 75 cents in change, or (if sold out) to prompt you to make another selection or get your dollar back. This is an example of a simple smart contract. Just like a soda machine can automate a sale without a human intermediary, smart contracts can automate virtually any kind of exchange.

A simple smart contract may function as a vending machine. Source: Frontu Obviously, smart contracts are deployed for much more complicated actions including releasing funds to appropriate parties, registering a vehicle, sending notifications, or issuing a ticket. Whenever a transaction is completed, the blockchain is updated and cannot be changed. The results are only accessible to all parties of the contract. In addition, smart contracts aren't legally enforceable. There is no legal framework existing that offers recourse in case of failure or error. In fact, some contracts depend entirely on the coding and development skills of the team behind them. If an error is made that creates security gaps or bugs, huge losses can be incurred. For example, one of the largest crypto hacks of all time was the DAO (decentralised autonomous organisation) attack on the Ethereum blockchain in 2016. In the attack, a hacker took advantage of what is called a recursive call bug and stole over 3.6 million Ether. At the time, that was worth over $170 million AUD. Because the hacker technically played by the rules of the DAO’s smart contracts, he claimed that he didn’t steal the Ether. It is important to note that the DAO hack wasn’t due to a failure of the Ethereum blockchain, it was simply a bug in the DAO built on top of the ecosystem. Since smart contracts are self-executing and self-arbitrating, they must cover every scenario and condition. What makes them secure is the fact that a public blockchain database maintains mutual trust. Everyone can see what transactions are taking place and must vote on them. Smart contracts are already revolutionising business, online communities, finance, and so much more. While the technology is still improving, its potential is inconceivably large, especially as the IoT and Web3 come into mainstream use.

Deployments of Smart Contracts

Currently, Ethereum is the foremost smart contract platform, although numerous other blockchain networks, such as EOS, Neo, Tezos, Tron, Polkadot, and Algorand, can also execute smart contracts. Anyone can create and deploy a smart contract on a blockchain, and the code governing these contracts is transparent and publicly accessible. This transparency enables interested parties to scrutinise the logic that a smart contract follows when handling digital assets.
Smart contracts are authored in various programming languages, including Solidity, Web Assembly, and Michelson. On the Ethereum network, the code of each smart contract is stored on the blockchain, permitting interested parties to examine the contract's code and status for validation of its functionality. Every node or computer on the network retains a copy of all existing smart contracts, along with their status, in conjunction with blockchain and transaction data.
Upon receiving funds from a user, a smart contract's code undergoes execution by all nodes in the network, leading to a consensus on the outcome and the subsequent flow of value. This decentralised process ensures the secure execution of smart contracts without reliance on a central authority, even when users engage in intricate financial transactions with unfamiliar entities.
Executing a smart contract on the Ethereum network typically incurs a fee known as "gas," essential for maintaining the blockchain's functionality. Once deployed on a blockchain, smart contracts are typically immutable, meaning they cannot be altered, even by their creators, with some exceptions. This immutability safeguards smart contracts from censorship or shutdown.

Smart Contracts Pros and Cons

Pros of Smart Contracts:

Accuracy: Terms are outlined in explicit details.
Transparency and Trustworthiness: Terms are accessible to all contractors.
Communication: Misinterpretation or miscommunication is unlikely.
Speed and Efficiency: No manual processing of documents.
Security: Smart contracts operate at a high level of data encryption.
Green: Smart contracts are paper free.
Backup and Storage: Transaction records are time-stamped and permanently stored. They are also easily recovered.
Cost savings: No need for intermediaries.

Cons of Smart Contracts:

The code is difficult to be changed: Code changing is practically and potentially expensive. Loopholes: A loophole may happen when ensuring smart contracts terms 100 reflect what parties agreed. Requiring third-party involvement: Developers may need someone who understands contract law to help explain to create specific codes. Vague terms: Smart contracts cannot handle vague terms or conditions. Lack of regulation: The blockchain industry is unregulated and is unregconised by traditional legal fields.

Smart Contracts Revolutionised Blockchain and Crypto

Smart contracts aren’t merely transactional. Today, blockchain developers can build complex applications called Decentralised Applications or DApps using smart contracts.

DApps are decentralised due to the design of blockchain ecosystems such as Ethereum. No central authority is necessary to execute and mediate agreements between parties. No single user controls the DApp, and all the rules are contained in the terms coded in the smart contract. Decentralised finance (DeFi) is one of the most well-known examples of DApps. For example, decentralised exchanges allow for complex transactions like lending, savings, or insurance without any central oversight. No institution or intermediary is required to facilitate transactions on these platforms. DeFi also ensures universal access to financial cryptocurrency services. Examples of advanced DApps include:
Compound is a platform that allows peer-to-peer lending and borrowing. Lenders earn interest on their crypto, and borrowers access funds easily and quickly. USDC is a stablecoin that keeps the value of one coin at the value of one dollar. It is a type of digital currency backed by the value of a fiat currency. CryptoMines is a SciFi game launched on the new Binance Smart Chain (BSC). CryptoMines allows players to explore the Metaverse and earn crypto tokens called ETERNAL. Raydium is a decentralised cryptocurrency exchange (DEX) running on Solana.

Smart Contracts FAQs

What is an Ethereum Smart Contract?

An Ethereum "smart contract" is a program operating on the Ethereum blockchain, comprising code and data located at a specific address within the Ethereum blockchain.

Why are Ethereum Smart Contracts Popular?

While Bitcoin, as the world's initial cryptocurrency, supported a basic form of smart contract, it was notably constrained in comparison to the advanced features offered by today's Ethereum smart contracts. Ethereum's creators intentionally designed the platform to facilitate transactions and enable functionalities not achievable on the Bitcoin blockchain. Ethereum stands out as the most secure, decentralised, and robust smart contract blockchain globally, having undergone rigorous testing and proven durability over time. This distinctive standing is unmatched by any other contract network currently in existence. Furthermore, Ethereum boasts the highest number of developers among blockchain networks, leveraging its potency and reliability to create innovative applications and smart contracts.

What can Smart Contracts be used for?

Smart contracts find utility in a wide array of scenarios necessitating agreements between two parties. They execute exclusively when specified conditions are met, fostering enhanced trust among involved parties. Some common use cases include:

  1. Digital Identity
    • Establishing identity for digital currency and other assets.
    • Mitigating counterfeiting and streamlining Know Your Customer (KYC) processes.
  2. Trade Finance
    • Facilitating cross-border payments.
    • Enabling swaps and fund transfers.
    • Supporting trading between various network assets.
    • Facilitating peer-to-peer payments, liability management, automatic payments for digital money, stock splits, and dividend payments.
  3. Financial Data Recording
    • Enhancing data recording by automating the process, minimising exposure to human error.
  4. Supply Chain Management
    • Automating supply chain processes for increased visibility and transparency.
    • Reducing instances of fraud, loss, and wastage.
    • Lowering transaction costs by eliminating intermediaries.
  5. Error-Free Financial Services
    • Leveraging mathematical code and calculations for precise and error-free financial operations.
  6. Government
    • Automating government operations to enhance efficiency and transparency.
  7. Insurance
    • Automating claims processing and dispute resolution within insurance companies.
  8. Mortgages
    • Streamlining the mortgage approval process through automation, significantly expediting it.
    • Reducing costs by eliminating middlemen from the mortgage process.

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