Introduction
Whether it’s your employment or a mortgage agreement, smart contracts cannot reach completion unless all their conditions are met. Similarly, some blockchain platforms can only advance if the smart contracts that run them see certain conditions or agreements fulfilled.
Smart contracts are self-executing transaction protocols or computer programs on the blockchain. They digitally facilitate an agreement’s control, verification, or execution after the set minimums have been met. Furthermore, smart contracts are one of the most critical features of blockchain technology. Their role is to eliminate third-party involvement, thus creating decentralized trust.
Developers can code in several conditions or agreements to execute automatically and without any third-party involvement. Once certain predetermined conditions of a smart contract are met, the following process progresses automatically. For instance, once two parties agree to trade cryptos on an exchange, a smart contract automates the coins’ transfer to both parties.
The concept of smart contracts can be pretty confusing, especially if you’re new to the crypto space. Read on to learn more about smart contracts, their area of applications, and popular crypto projects leveraging smart contracts!
What are Smart Contracts?
A smart contract is a self-executing contract on a blockchain network. This decentralized space can only fulfill its purpose when two parties meet the conditions they have previously coded into an agreement.
Smart contracts automate the execution, control, or verification of an agreement between anonymous parties. It doesn’t need a third party, external enforcement mechanism, or a legal system to function.
In smart contracts, all parties can be sure of the outcome when particular conditions are met. They can also automate processes by triggering the following action when certain conditions are met. The transactions or interactions with smart contracts can be subject to tracking and are irreversible. Furthermore, no one can delete or alter smart contracts to achieve specific goals.
Despite the name, smart contracts are not legally binding contracts. Their primary function is to programmatically execute certain transactions, processes, or tasks that developers have programmed into them. The execution of smart contracts can result in different processes. Among them are the delivery of services, exchange of money, and selective release of privacy-protected data. Lastly, they can unlock content under protection by digital rights management.
A Short History of Smart Contracts
Many credit cryptographer Nick Szabo for the creation of smart contracts. The computer scientist launched the concept 20 years ago. A graduate of the University of Washington, Szabo used the term “smart” to describe a set of digital promises. He told them as the terms binding two parties in a more functionally and smartly than paper-based contracts.
The case of a vending machine is a typical example of a smart contract. In a vending machine, a purchaser meets the contract terms by inserting money into the device. Then, the machine automatically honors the same terms by delivering a drink or snack.
The first concept of smart contracts goes back to 1996, and it comes from Ian Grigg and Gary Howland’s Ricardian Contracts concept.
The idea was part of their work on the Ricardo payment system in asset transfers. Bitcoin’s launch in early 2009 marked the first use case of smart contracts on blockchain technology. However, in 2014, the Ethereum whitepaper described the Bitcoin protocol as an unstable version of the smart contract concept that Nick Szabo first proposed.
Ethereum implements smart contracts to collect code and data at a particular address on the Ethereum blockchain. Thanks to smart contracts, Ethereum can support different applications such as Decentralized Finance (DeFi) platforms. Also, it can back dApps, games, NFT marketplaces, and more. Following Ethereum’s implementation of smart contracts, several crypto projects followed suit. They came up with different scripting languages to create smart contracts with advanced functionalities.
How Smart Contracts Function
Smart contracts function by following the “if/when…then…” concept. Developers have written this code on a blockchain. For example, if or when “x” occurs” then execute step “y” is how it may work. Once two parties meet certain predetermined conditions, the blockchain performs particular actions. This process may differ depending on the conditions in the smart contract. Nevertheless, the best part about them is their functioning without the involvement of a central authority or legal entity.
Some of the actions that follow the completion of a smart contract may include ticket issuance or token exchanges. Alternatively, they can release funds or verify a transaction, among others. The blockchain then progresses to a new, updated level.
The smart contract code can reach execution through specific provisions of an agreement. Also, it can complete the entire agreement between two parties. The code also replicates across multiple blockchain nodes. This means that it’s secure, permanent, and immune to changes by a single entity.
In most blockchain networks, users have to pay a transaction fee before the smart contract executes. For instance, on the Ethereum blockchain, the Ethereum Virtual Machine (EVM) runs smart contracts. However, it does so only after users pay a transaction fee (gas). In complex smart contracts, such as transactions involving more than two steps, gas increases to implement the smart contract.
Currently, smart contracts of blockchain are still rudimentary and have not yet reached a high-performance state. They can automate relatively simple actions such as executing transactions. Conversely, they can impose financial penalties when users do not meet the contract’s terms. However, with the significant growth in blockchain technology uptake, smart contracts should advance decisively soon.
How Smart Contracts are Created
Users create smart contracts by using a scripting language. In developing smart contracts, the parties must consult blockchain developers. This way, they determine how the predetermined conditions, i.e., transactions and their data appear on the blockchain. The developer then comes up with the “if/when…then…” rules that govern the functioning of the smart contracts. He does so after exploring all possible exceptions. Additionally, he has to create a framework that will facilitate the smooth execution of smart contracts.
One such example is Solidity. The Ethereum community came up with this programming language, the most popular smart contract application. However, smart contract applications using Solidity language can only run on the Ethereum Virtual Machine (EVM).
Other popular programming languages for developing smart contracts include the Digital Asset Modeling Language (DAML) and Web Assembly (WASM).
WASM enables developers to create smart contracts that can run in a web browser and integrate them into blockchains. Also, it can run on other distributed ledgers utilizing several programming languages such as C, JavaScript, Rust, and TypeScript.
On the other hand, DAML works best to create enterprise-focused smart contracts. These applications are ideal for business cases like supply chain management.
Benefits of Smart Contracts
Smart contracts can automatically and accurately execute processes such as transactions once the predetermined conditions have been met. Furthermore, smart contracts define rules and penalties in an agreement. Also, they can automatically enforce those obligations without the interference of a third party, human, machine, or additional program. Lastly, smart contracts offer plenty of benefits and use cases, stretching across different industries. Some notable benefits of smart contracts include:
Autonomy
Smart contracts automatically execute transactions and processes without the need for a third party. As such, brokers or other intermediaries are not necessary to complete transactions. Also, they are not mandatory to ensure users meet the terms of the agreements before executing consequent steps. The elimination of brokers, intermediaries, and other third parties lowers the risk of manipulation. Furthermore, it saves costs by abolishing the fees that could have otherwise gone to third parties.
Speed, accuracy, and efficiency
Smart contracts run automatically. For example, they facilitate the contracts’ quick execution once the parties meet the predetermined conditions. Furthermore, they enhance the process speed and efficiency of a blockchain network or an enterprise system. Additionally, smart contracts strengthen the accuracy of a function. For example, a process or transaction can only execute when users meet specific agreement terms. There’s no room for errors with smart contracts.
Safety
No one can alter smart contracts without the consent of both parties. Therefore, it guarantees trust in both parties. Also, some of them use encryption with cryptography. Consequently, they are immune to infiltration and modifications.
Trustless and Transparency
Smart contracts do the most to create a trustless system, where two anonymous parties don’t need to build trust. Thanks to smart contracts, there’s really no need for two parties to create trust and carry out transactions. Lastly, smart contracts operate on a decentralized network. This means the entire network is trustless. So, trades or transactions do not require trust as it’s the contract’s integral part to execute.
Cost-effective
By eliminating intermediaries and brokers, smart contracts make trades and transactions more cost-effective. In addition, smart contracts make transactions faster by removing the delays in transaction verification and confirmations.
Concerns with Smart Contracts
Despite their enormous benefits, smart contracts face issues and challenges that cloud their usability. These challenges are predominant in the business environment more than in distributed ledger networks. Some challenges facing smart contracts include:
Security
Despite being immune to alterations, smart contracts still face security and integrity challenges. This is because the technology is still new. So, hackers have identified loopholes where they fake events in the agreement. That’s how they trigger the execution of consequent processes to their benefit. For instance, Ethereum, in its early days, was the victim of hacking that saw it lose $50 million in crypto.
Termination and Amendment Challenges
In traditional contracts, both parties can reach a mutual agreement to alter or terminate the contract. However, smart contracts cannot be the subject of amendments or abrupt termination. For example, amending a smart contract is far more challenging than modifying a software code. That’s because smart contracts are immutable. So, even when both parties consent to the amendments, changing a smart contract is no easy task.
Furthermore, terminating a smart contract is also challenging. That happens even when an error giving one party an advantage appears in the agreement. However, most upcoming blockchain projects aim to solve these challenges. And, they do so by creating smart contracts that can quickly receive amendments or even reach termination.
Challenges in Scalability and Manageability
Smart contracts can automatically execute processes binding multiple parties. In case of damage to the contract or a security breach, the impact can quickly spiral out of control. Furthermore, it can lead to enormous losses across all parties. Stopping or unwinding such an event can be an issue, predominantly when the smart contract binds numerous parties.
Incompatibility to Business Environment
The ambiguity and vagueness of the traditional business environments make smart contracts less useful in such environments. The business ecosystem encompasses negotiable agreements. Usually, they involve cost-benefit analysis with various provisions in the agreement.
These provisions are ambiguous and cannot execute quickly as part of a smart contract. Simply put, a smart contract cannot perform vague terms. This makes them less useful in the traditional business environment.
Smart Contracts Use Cases in Real Life
Smart contracts have a myriad of use cases across various sectors. Some top use cases of smart contracts are:
Cross Border Payments
Smart contracts can revolutionize cross-border payments by enhancing the efficiency of buyers, suppliers, and institutions. Smart contracts can improve trust between different players and facilitate fast, accurate, and efficient payouts. However, for smart contracts to work effectively, a set of standard procedures is necessary.
Integrating smart contracts in cross-border payments can go a long way in creating an efficient payment system. Additionally, it can avert legal complications and solve legal issues surrounding cross-border payment systems.
Loans and Mortgages
Smart contracts can be helpful in streamline loans and mortgages. For instance, they can ensure both parties keep to the terms of loans and mortgages. Smart contracts can offer an error-free and efficient way of settling loans and mortgages. Also, they can guarantee that the parties reach every bit of the agreement. For example, a smart contract can efficiently manage a mortgage by tracking the payment bits. Finally, it can release the property only when the paying party has met the mortgage terms.
Supply Chain Management
Supply chain management is one of the significant use cases of blockchain technology. Smart contracts can enhance transparency and efficiency in supply chains by tracking the manufacturers and suppliers to the final consumer. Leveraging smart contracts in supply chains also reduces the cost and time in product verification and authentication. Smart contracts can provide trusted, reliable, and accurate supply chain data across multiple parties.
Governments
Smart contracts can automate government processes, including tax collection, property transfers, land title recording, and more. By leveraging smart contracts, governments can enhance transparency in their operations and prevent corruption. Also, smart contracts can improve service delivery from governments to benefit their citizens.
Insurance
Insurance companies can use smart contracts to settle valid insurance claims only. For example, one can only pay an insurance claim if it meets the terms in the insurance agreement. If one party breaches the insurance contract terms, the insurance claim cannot reach a settlement.
An insurance company can automate an insurance claim settlement by integrating the smart contract code into the policy documents. As such, the insurance contract can execute itself once the insurance policy fulfills its agreement terms. This goes a long way in averting fraud and false settlements.
Medical Research
Smart contracts can be helpful in medical research to automate clinical trials. For example, it can guarantee that certain conclusions drop from the prosecution. Also, the data and crucial information from the test can instantly reach multiple parties through the blockchain’s automatic sharing system.
Top Blockchain Platforms that Leverage Smart Contracts
Ethereum
Ethereum appeared in 2015. It is the leading smart contract platform with the lion’s share of decentralized applications (DApps). Currently, 80% of all dApps in the crypto space run on Ethereum. Deploying smart contracts and DApps on Ethereum is simple, thanks to straightforward rules. Also, convenient development guidelines and a standard smart contract coding language, Solidity, contribute to this.
The Ethereum smart contract platform offers plenty of benefits, including support, security, and standardization, among others. It’s no surprise that it has more than 200 000 developers, making it superior to any other smart contract platform.
The large number of dApps, Defi, ICOs, and other applications on Ethereum has pros and cons. For example, the network’s congestion reinforces its position as the leading smart contract platform. However, it also amplifies its scalability issues leading to slow transaction speed. Lastly, the exceptionally high transaction processing fees make it inaccessible for some.
Lastly, Ethereum has a history of smart contract breaches. For example, many hackers compromised some smart contracts and stole millions of dollars in cryptos.
Nevertheless, the past security breaches have nothing to do with the platform but with insecure smart contract codes.
Ethereum looks to migrate to Ethereum 2.0 to solve some of the challenges facing the platform. Many hope that this will fix scalability issues, high gas fees, and other security vulnerabilities. This should occur in 2022, but the event doesn’t have a specific date yet.
Polkadot (DOT)
The mastermind behind Polkadot (DOT) is Gavin Wood, an Ethereum co-founder and Solidity creator. The smart contract stands out for its interoperability feature, connecting various blockchain ecosystems. The platform’s key component is the Relay Chain, consisting of parachains and parathreads, responsible for network interoperability.
The parachains in the Polkadot ecosystem enable developers to create their own blockchains. Furthermore, they can create custom governance models and tokens. This feature can also be helpful as shards to facilitate the parallel processing of transactions. As a result, it should enhance scalability and transaction speeds. The Polkadot network also leverages bridge chains to connect parachains to external blockchain networks.
A famous smart contract on the Polkadot ecosystem is Moonbeam. This smart contract is compatible with Ethereum. Also, it allows developers to deploy smart contracts using Solidity to the Polkadot ecosystem. Above all, they can do so without significant functionality changes.
Polkadot’s outstanding interoperability capabilities make it a solid competitor to Ethereum. Most importantly, they can spur smart contract adoption.
Cardano (ADA)
On 12Th September, Cardano implemented the Alonzo hard fork ushering in smart contracts on the platform. This means that non-custodial lending apps, decentralized exchanges, and other applications could run on the platform.
The Cardano founder, Charles Hoskinson, stated that the platform’s term “smart contracts” was semantically incorrect. Instead, the crypto community should use “programmable validators” when referring to smart contracts on the Cardano platform. This is because Cardano leverages the “eUTXO” transaction model. This feature is different from other smart contract platforms such as Ethereum and Solana.
In simple terms, users cannot deploy smart contracts on the Cardano blockchain. Instead, the hash functions can reference validators before use and only reveal them after activation. The programmable validators are fully determinable. This means that their outcome depends entirely on the transaction it bears, i.e., predictable fees. Following Hoskinson’s clarification, it’s not clear whether Cardano is a smart contract platform.
Solana
A handful of software engineers from Dropbox, Intel, and Qualcomm, created Solana in 2017 as a new-gen smart contract platform. The platform solves the scalability issues that most smart contract platforms have. It does so with its ability to process over 65,000 transactions per second. The platform leverages the Proof of History (PoH) consensus mechanism. This way, every transaction forms a single block and becomes the following transaction input. In this mechanism, it’s possible to identify the order of transactions on a particular block.
Solana also processes smart contracts in parallel thanks to innovative technologies such as Sealevel. Solana’s immense scalability and transaction speed make it attractive for decentralized applications. Also, enormous DEXs or any other applications requiring instant transactions can use it.
Algorand (ALGO)
Algorand is the brainchild of MIT professor Silvio Micali. It is an excellent smart contract platform that focuses on scalability, low costs, and transaction speed. It should achieve all of these without compromising security. Algorand smart contracts are fast, powerful, and inexpensive. Furthermore, they are the first-ever carbon-negative smart contracts.
Algorand smart contracts use a higher-level programming language. The Layer-1 Algorand Virtual Machine (AVM) compiles bytecode and executes it. Popular smart contracts languages on Algorand include Reach, Python, and Clarity. All these languages are easy to understand by both novice and expert developers.
Other popular smart contract platforms include Stellar, Tezos, Hyperledger Fabric, Ergo, Avalanche, Algorand, and more.
Takeaway
Smart contracts are self-executing transaction protocols on blockchain that facilitate an agreement’s control, verification, or execution. It does so only after the users meet the conditions of the deal. Blockchain-based smart contracts make transactions and other processes trustless, transparent, and secure. Furthermore, they increase their efficiency and make them cost-effective.
Smart contracts have a myriad of applications across different industries. From supply chain management to healthcare automation and cross-border payments, smart contracts can automate these processes. Also, they eliminate the need for third parties. Simply put, it leads to lower costs, more transparency, and a low risk of fraud.
Ethereum is currently the most popular smart contract platform. For example, it hosts close to 80% of the decentralized applications in the crypto space. But with the scalability issues and high transaction fees, it’s only a matter of time before another smart contract platform overtakes it. Among the leading candidates are Cardano and Solana.
Smart Contracts Timeline
1996
Inception
- Nick Szabo introduces the concept of “smart contracts” in his paper “Smart Contracts: Building Blocks for Digital Markets.’’
- Ian Grigg and Gary Howland come up with a similar form of smart contract. They developed it as the Ricardian Contract in their Ricard payment system, which would enable asset transfers.
2008
Bitcoin
- Satoshi Nakamoto ushers in the blockchain era through his paper, “Bitcoin: A Peer-to-Peer Electronic Cash System.”
2015
Smart Contracts Era
- Vitalik Buterin and a handful of crypto investors and developers launch Ethereum. The innovative blockchain concept uses smart contracts as the core for its operations. Also, it was the first platform to allow users to create and execute decentralized applications, DeFi, and ICOs.
- Charles Hoskinson, one of Ethereum’s co-founders, launches Cardano. The blockchain platform aims to enable secure peer-to-peer transactions through its native token, ADA.
2017
Legal Smart Contracts
- Belarus became the first country in the world to legalize smart contracts.
2018
US States Legalizing Smart Contracts
- Several U.S. states, such as Arizona, Nevada,Tennessee,and Wyoming passed a bill legally recognizing smart contacts.
2020
The DeFi Craze
- The great DeFi craze sees the number of decentralized financial applications explode. Many of the new DeFi protocols were built and run on the Ethereum blockchain. Above all, smart contracts fueled their development and rise to popularity.
2021
UK Smart Contracts Bill
- the UK Jurisdiction Taskforce (UKJT) published the Digital Dispute Resolution Rules (the Digital DR Rules) to help accelerate resolution in blockchain-based conflicts. The measure should also clear the air in disputes regarding faulty smart contract codes or when parties do not meet the conditions in an agreement.
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