What Are Smart Contracts? Everything You Need To Know
Crypto Guides
Crypto Guides
May 25, 2023

What Are Smart Contracts? Everything You Need To Know

What Are Smart Contracts?

A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network. The code controls the execution, and transactions are trackable and irreversible.

Smart contracts permit trusted transactions and agreements to be carried out among disparate, anonymous parties without the need for a central authority, legal system, or external enforcement mechanism

Smart Contract Explained

A smart contract, a decentralized software, will execute its business logic when specified conditions are met. A smart contract that is implemented may result in the transfer of funds, the supply or service of commodities and/or media protected by digital rights management, or the alteration of other data, such as land title renaming. For instance, smart contracts may be used to enable the selective release of encrypted data to meet a specific requirement for privacy protection.

There are many designs for developing, distributing, managing, and upgrading smart contract programs. In a variety of payment systems and digital exchanges, blockchains and other distributed ledger technologies may be used to store and trade these tokens, as well as other cryptocurrencies such as bitcoin.

Contrary to their name, smart contracts are not legally binding. They are often used to execute business logic programmatically in response to a set of conditions by completing various activities, processes, or transactions. The parties must take legal action to guarantee that its execution is conditional on the existence of a legally enforceable agreement.

How Smart Contracts Work?

American computer scientist Nick Szabo's "Bit Gold" virtual money was proposed ten years before bitcoin in 1998. Szabo pioneered the use of smart contracts in 1994. While Szabo has denied being Satoshi Nakamoto, he has long been suspected of being the real Satoshi Nakamoto. A smart contract is a computer-implemented transaction mechanism that carries out the terms of a contract. The capabilities of electronic transaction systems such as POS (point of sale) must be expanded into the digital realm.

In his work, Szabo also proposed a contract for synthetic assets, such as derivatives and bonds. Szabo asserts, "These new assets are created by combining securities (such as bonds) with derivatives (such as options and futures). By analyzing complex payment conditions using computers, it is now feasible to standardize and trade these contracts at low transaction costs." Numerous forecasts made by Szabo in the paper came true before introducing blockchain technology. Numerous instances exist, such as derivatives trading, in which computer networks make use of sophisticated term structures.

Applications of smart contracts and blockchain technology 

  • The blockchain's immutability and security make it ideal for storing smart contracts. The data stored in a smart contract's blocks are encrypted and hence cannot be lost.
  • Another advantage of smart contracts, which use blockchain technology, is that they may be adapted to the parties' specific requirements. Developers may use a blockchain to store almost any kind of data, and there are several transaction types.
  • Smart contracts based on blockchain technology are being used to enhance the efficiency and security of several corporate activities to cut transaction costs.
  • Cook County, Illinois, for example, used blockchain technology in 2016 to create a database for the transfer and tracking of property titles. Additionally, the purchaser receives a digital token that may be used in combination with the traditional paper deed as proof of ownership.
  • Supply chains across a wide variety of industries may benefit from blockchain-based smart contracts. Automating healthcare payments using smart contracts makes it feasible to reduce overbilling and fraud. When music is used commercially, a smart contract on the blockchain may ensure that royalties are paid. The automobile industry may benefit from the easy storing of information on vehicle maintenance, accidents, and ownership history through smart contracts and blockchain.
  • On Ethereum, a well-known cryptocurrency platform, smart contracts may be constructed. The Ethereum community designed the Solidity language to facilitate the development of smart contract applications for the Ethereum Virtual Machine (EVM) execution environment.
  • Two more popular programming languages are WebAssembly (WASM) and Digital Asset Modeling Language (DAML) (DAML). WASM supports a broad variety of programming languages, including C, JavaScript, TypeScript, and Rust, enabling programmers to create smart contracts that can be executed in a web browser and integrated into distributed ledgers. DAML is a business-oriented language that enables privacy measures to be enforced while modeling a variety of economic use cases. 

Pros of smart contracts

  • Efficiency and accuracy

Rather than depending on paper documents, smart contracts reduce the possibility of human error by automating the execution of transactions.

  • Trustworthiness

There is no reason to suspect that information has been modified for personal advantage without a third party and encrypted records of transactions between participants.

  • Security

Blockchain transaction records are encrypted, making them very difficult to decrypt. For one thing, hackers would have to modify the whole chain of entries in a distributed ledger to alter a single one.

  • Savings

The implementation of smart contracts removes the need for third-party transaction processing, as well as the delays and expenses associated with it.

Cons of smart contracts

  • Security

Multiple parties to a commercial transaction may feel secure when smart contracts are used. Due to the rapid advancement of technology, hackers are continuously devising new methods to circumvent the laws enacted by the corporations that produced them. Smart contract hackers stole an estimated $50 million in cryptocurrency during Ethereum's early days. Additionally, the IEEE voiced concern about the disparate methods utilized to uncover various smart contract security issues.

  • Integrity

At least one oracle (one of the streaming data sources that provides event updates) must safeguard against hackers manufacturing events that cause smart contracts to execute when they should not. It must be constructed so that relevant events are generated, which may be challenging in complex conditions.

  • Alignment

Regardless of whether all parties' objectives and understandings are aligned, smart contracts have the potential to accelerate activities involving many parties. When events spiral out of control, and there is no mechanism in place to prevent or reverse unanticipated behavior, this ability may amplify the impact of any resulting damage. According to Gartner, smart contract scalability and administration challenges have not been resolved.

  • Management

Smart contracts are fairly challenging to construct and manage. Often, it's almost impossible to change their setup. While this may seem to be a security advantage, the participants in the smart contract agreement cannot modify or add new features without drafting a new contract.

Future of smart contracts

Smart contracts have applications much beyond the simple transfer of assets since they may be utilized for many reasons. They may manage legal proceedings, insurance premiums, crowdfunding agreements, and financial derivatives. Intermediaries in the legal and financial sectors, such as banks and lawyers, may be removed via the implementation of smart contracts, which simplify and automate routine and repetitive tasks.

Lawyers' jobs may change in the future if smart contracts can adjudicate standard contracts and generate adaptive templates. There are several compliance advantages associated with the usage of smart contracts, which automate activities and manage behavior and give real-time auditing and risk assessment.

Additionally, smart contracts may be used to automate processes associated with the Internet of Things and edge computing. Utilities, for example, may provide a service in which smart contracts execute in response to changes in energy price, in conjunction with devices embedded in power meters. For example, when prices reach a specific threshold, IoT controllers may be configured to automatically turn off or limit the power usage of energy-intensive equipment such as air conditioners.

Additionally, smart contracts may be incorporated into vending machines, releasing commodities in response to bitcoin payments.

Smart contracts may release payments when a shipping container reaches its ultimate destination provided IoT sensors demonstrate that the container has not been opened and that its contents have been kept at the right temperature, humidity, and vibration levels.