Smart contracts are automated agreements between the contract’s owner and recipient. This agreement, which is encoded in blockchain, is immutable and irrevocable. Ethereum, the second most popular blockchain globally, popularized smart contracts, which led to a range of decentralized applications (DApps) and other use cases on the network.
Automation of operations that formerly needed a third-party intermediary is a crucial benefit of blockchain networks. For example, a smart contract may automate the process rather than requiring a bank to approve a client-to-freelancer money transfer. The only need is for two parties to agree on a single notion.
The History of Smart Contracts
Believe it or not, smart contracts predate blockchain technology. Nick Szabo, a cryptographer, initially suggested the notion in the 1990s. Ethereum is the most well-known implementation of the protocol.
Many individuals, including the website for Ethereum, compare smart contracts to vending machines. A vending machine enables a seller to offer a consumer a product without the need for a person to accept payment and deliver the item. Smart contracts serve the same purpose but are far more adaptable.
In recent years, smart contracts have made great strides forward. They originated as simple if-then sentences that a programmer might construct and execute. On the other side, those with programming expertise are confined, centralizing these “trustless” contracts. Thankfully, the same developers are working to solve accessibility concerns.
How do Smart Contracts operate?
Consider these contracts as digital “if-then” statements between two or more parties. If the demands of one group are satisfied, the agreement may be respected, and the contract is considered fulfilled. For example, imagine that a market has requested 100 ears of corn from a farmer. The former will lock payments into a smart contract, which may then be authorized upon delivery by the latter.
When the farmer completes their work, the funds will be immediately issued. If the farmer misses the deadline, the contract is terminated, and the customer receives a refund. The above use case is somewhat narrow. Smart contracts may be designed to replace government regulations and retail systems, among other things.
Programming underpinning smart contracts are primarily responsible for this security. For example, Ethereum contracts are written in the Turing-complete computer language Solidity. This implies that the rules and constraints of smart contracts are encoded into the network’s code and cannot be changed by a malicious party.
In technical terms, the notion of a smart contract may be broken down into several components. A smart contract needs, first and foremost, an agreement between two or more parties. Once this is validated, the parties may negotiate the conditions under which the smart contract will be deemed complete. The decision would be codified in the smart contract, encrypted, and stored on the blockchain network.
Upon completion of the contract, the transaction is recorded on the blockchain in the same manner as any other transaction. Then, with this transaction, each node will update its copy of the blockchain to reflect the new “state” of the network.
You may wonder whether smart contracts are compatible with Bitcoin and other networks. Yes, to a degree. Every Bitcoin (BTC) transaction is theoretically a streamlined form of a smart contract, and layer-two solutions to expand the network’s capacity are now under development. Ethereum’s use of smart contracts, however, is exceptional.
Where are smart contracts applicable?
Several possible applications of smart contracts may automate the world and make it a better place to live and the payments example discussed above. Here are some well-known applications of smart contracts.
Identifying oneself in the digital age
On the internet, knowledge is a valuable commodity. Companies profit by understanding everyone’s interests, but individuals do not always control how this information is gathered or benefit from it. People govern smart contracts.
Identity will be tokenized in a future based on blockchain technology. Each individual’s identity would live on a decentralized blockchain in a perfect world, protected from malicious actors. Now, suppose a user wishes to utilize social networking or submit papers to a bank for a loan. In that case, they may benefit from the former while maintaining control over the latter’s transaction process.
An intermediary does not manage a social media network. Users may choose what information to make public and what information to keep private. If users participate in information sharing, they may construct a smart contract and pick which data is sent, rather than just collecting all of the user’s information. There is no third-party collecting cash or surreptitiously keeping and selling data; the user alone benefits.
The same applies to interactions with banks and other financial institutions. The primary purpose of communication is to communicate important papers and information. There is no chance that a lender would keep your email address and sell it to other credit companies. This information is entirely under the user’s control.
Real Estate investment
In the past, real estate agents were a necessary evil. However, because selling a home is a long and complex process, owners will hire a broker to handle the troublesome aspects, such as paperwork and finding a buyer. Even though this may look favorable for the seller, brokers charge a significant portion of the transaction price.
A smart contract may be used instead of a broker to expedite the house-transfer process while preserving the same degree of security. This is when the label “untrustworthy” comes into play.
Consider that the title to your home is tokenized on the Ethereum blockchain. If you are prepared to sell it, you and the buyer will engage in a smart contract.
The seller saves money by not paying an intermediary, and the buyer obtains the home much sooner than if an intermediary were involved.
Intelligent contracts might be pretty beneficial for insurance coverage. Consumers engage in a smart contract with the provider when consumers purchase insurance. All policy criteria would be included in the smart contract, which the user would then read and sign if they approved.
This agreement would stay in force until the responsible party requested its termination. After uploading the required documentation demonstrating their need for insurance payment, the cash would be disbursed. This contract avoids the need to speak with people and insurance providers. At the same time, the user would still be required to provide supporting documentation for their needs.
The supply chain
The supply chain is one of the most popular uses of blockchain technology and smart contracts.
Farmers, office warehouses, grocery shops, and others contribute to the supply chain. However, as these networks get more complex, it becomes more difficult for firms to monitor product custody and following payments, among other things. Smart contracts can potentially automate and incentivize all segments of the supply chain to increase responsibility.
The grocery shop may employ smart contracts to automate each step of the check-out process. Even if these check-ins are already present in a standard supply chain, they must be conducted manually. An individual may count the objects and record their arrival. They may steal certain items and claim that others were lost. Supply chain theft is a significant problem that costs the United States $35 billion annually.
Smart contracts are distinguished by their absence of trust. For example, the shopkeeper may stipulate that payment be withheld until all apples have been tallied. As there is no way to circumvent this mechanism, parties will be more careful with their supply. Moreover, payment will be made quickly to the receiving party, which is an incentive in and of itself.
Negative aspects of Smart Contracts
Although smart contracts are an excellent concept in principle, they are not perfect. First, remember that smart contracts and blockchain networks are designed manually. Therefore, human error is inevitable, and it may result in exploitation. This occurred in 2016 with the assault on Ethereum’s Decentralized Autonomous Organization (DAO). Using a weakness in the DAO’s fundraising smart contract, hackers stole cash from the project.
Not to mention that these autonomous agreements lack regulatory clarity. On paper, the notion of a safe, simplified money transfer procedure is impressive; however, taxes and other government involvement must also be considered.
In addition, smart contracts cannot access information outside the network in which they are embedded. Certainly not in their present condition. In other words, current website data cannot be added to an Ethereum smart contract. Oracles, which are off-chain nodes that extract information from the internet and transform it to be compatible with blockchain networks, provide a solution.