22. Smart Contracts – what are they?
Have you ever wondered what the smart contracts are? Today’s lesson will be dedicated to explaining in detail what smart contracts are. Interestingly, the idea of smart contracts is also used daily, which not many people have any idea about. What they are and what they are used for – today we will answer these questions.
Smart contracts – definition
Smart contracts are a computer program or protocol running on a blockchain network to create digital smart contracts. They consist of a code that defines entry and exit conditions. After meeting them, we get the specific results we wanted. Thanks to the fact that smart contracts operate based on blockchain technology, many people are able to benefit from their results, which are accurate, timely and, above all, resistant to third-party manipulation.
Smart contracts are a powerful tool for automating many industries, not just cryptocurrencies or blockchain technology. Thanks to the fact that they are not controlled by a central authority, they are fully independent. What’s more, they are resistant to hacking attacks by individual cybercriminals. They increase efficiency, reduce costs and increase process throughput. They are very useful when we are talking about Bitcoin, Ethereum or modern technology.
How do they work?
At this point, we need to remind ourselves of the logic. As we have already mentioned, smart contracts are computer programs operating on blockchain technology. They use the following logical condition: “when a happens, perform action b”. One smart contract can meet many conditions, just like one application can use many smart contracts to operate.
Each developer can create their own smart contract in the programming language of their choice. Because the most popular network for their creation is Ethereum (Link: · Ethereum – what is it, how does it work, description of its native token), no one will be surprised that the most popular language for their coding is Solidity. Once the smart contract is programmed, it needs to be deployed on a public blockchain. They can also be used for their purposes, e.g. profit multiplication. However, it is worth knowing that smart contracts precisely define the rules on how users can interact and contract with them. Everything, of course, depends on the ecosystem we use to create them.
What does such a smart contract look like? Here are some examples:
Condition 1: If the ordered goods arrive on time, pay the contractor the full amount.
Condition 2: If the ordered goods arrive one day late, pay the supplier 95% of the agreed amount.
Condition 3: If the user deposits 1 BTC of collateral in a certain contract, lend 50% of your collateral.
Condition 4: If the value of user’s collateral falls by 50%, then transfer give it to the lenders and automatically liquidate it.
Of course, everything is written based on an appropriate code, following prior agreement between the parties wishing to enter into such a contract. At this stage, you have surely noticed that the purpose of smart contracts is to automate processes. Not only in the cryptocurrency industry, the Ethereum ecosystem or blockchain technology.
Smart contracts support dApps which, as you know from previous lessons, you can interact with without having any authorizations.
Advantages of contracts
Security – no failures. Smart contracts have a decentralized formula. There is also no intermediary that can be bribed or manipulated by one of the parties.
Reliability – thanks to the coding language (Ethereum Solidity) and logic, they are incredibly efficient. We have a guarantee that the contract will be executed according to the agreed terms.
Efficiency – no need for manual data entry. There is also no intermediary laboriously entering the necessary data for transactions. The whole process is fully automatic.
Fairness – no privileges for any party to the contract.
One of the most serious disadvantages that exist with smart contracts is the inability to edit their content after saving the code on the blockchain. Once created, a smart contract cannot be corrected or upgraded.
Another is regulatory law. Contracts are not regulated by any legal standards.
Now for some historical trivia. Smart contracts were first introduced by Nick Szabo in 1994. According to him, the definition of smart contracts was: “a computerized transaction protocol that executes the terms of the contract.” As the popularity of digital assets grew, so did the popularity and demand for smart contracts. They wanted a tool that is tamper-proof and completely decentralized. In this way, they demand.
The demand for this type of computer code has increased significantly. And with the popularity of Bitcoin and other cryptocurrencies – it has grown even more.
The use of smart contracts
We can use them to track and assign ownership rights to digital tokens on the blockchain network. Such a contract then programs specific functions into the tokens, e.g. insurance (utility token in dApp`s) or even capital security (security token).
DeFi – in decentralized finance, contracts are used to create traditional financial products and services, e.g. storing user funds, creating financial markets, asset management.
Play2Earn Games. Contracts make the actions in a game immune to manipulation by its users. Moreover, smart contracts distribute the loot gained by randomness and guarantee players an equal chance of winning.
NFT – in this case, contracts provide a fair model of their distribution.
Do smart contracts have any limitations?
Yes. And the answer will be surprising, their limitation is blockchains. Blockchains are not connected to the outside world. As a result, contracts do not communicate externally to, for example, confirm the occurrence of some events in the real world. They also do not have access to all the calculation data. Without a connection to reality, contracts do not use 100% of their potential.
Considering the above, developers are working on the evolution of the blockchain. Programmable smart contracts that can connect to the real-world outside the blockchain are already being developed. They use extended input and output algorithms to do so.
Another solution that I’m sure has come to mind is to use the oracles. With these, blockchains are connected to legacy systems and smart contracts. While maintaining the security and reliability of the underlying blockchain.
We want to believe that in the near future, smart contracts will become an integral part of our lives. Of course, before that happens, we have a long way to go and many problems to overcome.