Smart contracts are one of the most popular buzzwords you’ll come across in the crypto space. While people who have been in the crypto space for some time know exactly what a smart contract is, newbies may not have a clear understanding. So whether you’re new to the crypto space or you have been here for a while but still don’t know exactly what a smart contract is, today’s post should give you all the information you need to know about smart contracts.
For starters, smart contracts are typically automated agreements between the contract creator and the recipient. These automated agreements are written in code and baked into the blockchain. The process makes the agreement binding on all parties. Not just that, it also makes the agreement immutable and irreversible.
While smart contracts have become commonplace in the crypto world, the term became famous following the launch of the world’s second-largest cryptocurrency by market cap, Ethereum. Thanks to Ethereum’s smart contract feature, the network has seen the launch of many exciting decentralized applications (DApps) with significant use cases.
One of the most intriguing benefits of blockchain networks has to be the automation of tasks that would typically require a third-party intermediary. For instance, instead of needing a third party like a bank to approve a fund transfer from, let’s say, a client to a freelancer, using smart contracts, the process can be automated; how cool can that be? All that needs to happen is for the two parties involved to agree on a defined concept. It’s that easy.
Another example that can be used to explain the practical working of a smart contract is between a regulatory group and the citizens it represents when debating a law. If the two parties were to come to an agreement in a blockchain-based system, the law would be put in place using a smart contract. And readers can read everything about the new law via a uniquely designed DApp or also interact with the law via a blockchain-based way.
A brief history of smart contracts
Smart contracts have been with us even before the coming of blockchain technology. Even though Ethereum, which was launched in 2014, serves as the most popular implementation of the smart contract protocol, a cryptographer, Nick Szabo, first introduced the term smart contract in the 1990s.
Back then, the cryptographer, Szabo, was in the process of developing a digital currency dubbed Bit Gold. While his concept never came to fruition, this bitcoin predecessor highlighted the smart contract use case, especially as his proposed digital asset conceptualized trustless transactions on the internet. If Web 1.0 represented the internet itself and Web 2.0 gave rise to centralized platforms, then Web 3.0 is an automated, trustless, and user-powered version of the digital space.
Many crypto gurus, including the Ethereum website, have made a case for smart contracts, comparing them to a vending machine. Let’s give you a bit of an explanation, so you know exactly where we are driving at. A vending machine serves the purpose of a vendor who provides users with products without needing a person present to collect money and hand products to buyers. Even though smart contracts work almost the same way, the main difference between the two is that smart contracts are a lot more versatile.
Thanks to advancements in technology, smart contracts have evolved remarkably over the last couple of years. Smart contracts kicked off as simple “if-then” statements that programmers create and implement. However, most of the programmers in the space, especially during the early days of smart contracts, were limited in their knowledge of how to truly leverage these trustless contracts. Thankfully, the crypto space is now home to some of the most experienced developers who are working round the clock to resolve accessibility problems that are common with smart contracts.
Since the launch of smart contracts, developers have designed smart contracts to be almost seamless, that anyone without robust coding knowledge can build their own smart contract. And good enough, developers are working round the clock to beef security on smart contracts using different programming languages. They are also creating alternatives like secret smart contracts while designing tons of ways users can automatically store smart contract history via a human-readable format. This makes a smart contract a lot easier to read than using the blockchain.
Understanding how smart contracts work
To get a clear picture of what smart contracts are about, we want you to think of the contract as digital “if-then” statements that are binding on two or more parties. Once the need of one group is met, you can expect the agreement to be honored, in which case the contract is considered complete. Sounds confusing? Well, read on as we will expand on this to make things a bit easier.
Let’s say, for instance, a market makes an order for 100 ears of corn from a farmer; the market will proceed to lock funds into a smart contract that will eventually be approved when the farmer delivers on the orders. Once the farmer delivers all 100 ears of corn, the funds will automatically be released to the farmer. On the flip side, if the farmer fails to uphold his own end of the agreement and does not deliver on the said date, the contract is automatically canceled, reversing the funds to the market that initiated the smart contract earlier. Easy now, right?
Just so you know, the above explanation is just a tiny use case for smart contracts, and that’s because smart contracts can be deployed into almost all human endeavors, including being programmed to work for the masses, replacing governmental mandates and retail systems, among tons of other benefits. Also, let us quickly add that smart contracts will eliminate the need to bring certain disagreements to court, saving parties involved tons of money and time.
The security enjoyed by smart contracts is mainly due to the inherent smart contract code. For instance, on the Ethereum network, smart contracts are written using the network’s Solidity Programming language, which has been described as Turing complete. What this means is that the rules and limitations of smart contracts are effectively embedded into the network’s code, making it difficult for any bad actor to manipulate the rules. Ideally, these limitations are baked into smart contracts to mitigate hidden contract alterations and scams. And just a quick reminder, a smart contract is only binding once all participants agree and sign on the matter.
To explain smart contracts in more technical terms, we will attempt to break down the idea of smart contracts into a couple of steps. To start with, a smart contract requires an agreement between two or more parties. Once the parties have reached an agreement, they can then proceed to layout and agree on conditions in which the contract will be considered complete. Their decision will then be written into a smart contract, encrypted, and stored on the blockchain network.
Once the contract is complete, it will be recorded on the blockchain just like any other transaction. After that, all nodes will update their copy of the blockchain to include this transaction, hence updating the new state of the contract on the network.
At this point, we are sure you’re wondering if Bitcoin and other networks can leverage smart contracts. To some certain extent, yes. Every bitcoin transaction is technically a watered-down version of a smart contract. And just to update you, layer two solutions are in work. This will effectively expand the network’s functionality. That said, Ethereum’s use and deployment of smart contracts is a unique case.
Unlike other blockchain networks described as a distributed ledger, Ethereum, the second-largest cryptocurrency by market cap, is typically considered a distributed state machine, featuring what most people have come to know as the Ethereum Virtual Machine (EVM).
For those who have no idea, the machine state of Ethereum is the point where nodes agree to keep a copy of the smart contract and stores the smart contract code along with the rules by which all parties must abide. Since every Ethereum node features the rules baked via code, it means that all Ethereum based smart contracts have the same limitations.
Where can smart contracts be applied?
Besides the payments example we expounded on above, there are tons of exciting implementations of smart contracts that can be used to automate the world and make it an easy place to live for everyone. Here are some brilliant examples of smart contract use cases you should know.
In the digital world, information is currency. Many companies on the internet today make millions in profits from knowing people’s interests. The unfortunate thing is that a lot of people are not always in control of how the data is acquired. Also, they do not profit from it. But with the deployment of smart contracts in this area, people will control their data.
With the advancement in blockchain technology, we expect identities to be tokenized in the near future. If we ever reach this point, it would typically mean that each person’s identity exists on a blockchain where it is safe and secured from any type of bad actor. For instance, if a user wants to submit documents to a bank for loan purposes or participate on a social media platform, they can control the transaction process in the former and profit from the latter.
In terms of social media, there will be no central authority controlling the network. Instead, users have the sole right to determine which information should be made public and which should remain private. If they want to participate in information exchange like an endorsement, they can simply create a smart contract and decide the data to be transacted, rather than taking everything pertaining to the user. Also, there would be no third parties to take some of the funds or secretly store or sell that data. With this, only the user profits.
The same scenario plays out when dealing with banks and other financial bodies. Communication will only involve users sending the required documents and vital information over. This way, there will be no risk of a loan group storing your email and pitching it to other credit companies, as such info will be solidly under a user’s control.
Real estate brokers in the traditional world have been dubbed a necessary evil, and we don’t agree any less. Considering that the process of selling a home is a bit long and convoluted, homeowners have to hire a broker to handle the confusing aspects. What we mean here is the challenging paperwork process and actually finding a buyer. While this arrangement may sound ideal for a home seller, keep in mind that brokers usually demand a significant fee for selling a home.
The good news is that a smart contract can take the position of a broker and will seamlessly streamline the house transfer process while ensuring that the deal is just as secure as it is with an intermediary. With the trustless moniker that comes with smart contracts, you can be sure that the deal will go smoothly.
Just imagine for a second that the deed to your home is tokenized on the Ethereum blockchain. Whenever you want to flip your home, all you need to do is create a smart contract with the buyer. The smart contract will hold the deed in escrow until the fund from the buyer is submitted. Once that’s done, the deed will be released.
Deploying smart contracts to real estate dealings will undoubtedly be a win-win situation for everyone involved. On the one hand, the seller saves money that would have gone to an intermediary while the buyer gets his desired home sooner than he would have imagined.
The insurance industry can easily benefit from smart contracts. With all of the awesome perks that come with smart contracts, one can only imagine how smart contracts can improve insurance policies.
By deploying smart contracts to the insurance industry, it will mean that signing up for a policy will essentially enter the user into a smart contract with a provider. With this arrangement, all policy requirements will be outlined adequately in a smart contract, with users reading the agreement and signing it if they are happy with the terms.
The contract will be left open until a liable party needs it. And should that be the case, all they need to do is upload the required forms with proof of their need for insurance payment. Once that’s done, the funds should be released.
With this type of contract, users will no longer need to communicate with insurance groups and individuals. Even though the user would still need to complete paperwork to prove their requirements, the subsequent submission and the funding process will be near-instant.
As per the identity aspect, we must add that all drivers will need to have a record of their accident reports. Also, drivers will need to have all critical insurance information with them. This could result in lower rates for good drivers, especially drivers with no blemishes on their driving history.
The supply chain is one of the industries that will benefit immensely from the deployment of smart contracts into its operations.
Office warehouses, grocery stores, farmers, and other players in the supply chain have their place and role to play. But given how complex these networks are becoming, companies find it pretty challenging to keep track of product custody and payments, not to mention other things. With smart contracts, the whole process can be automated and incentivized to increase their accountability.
For instance, let’s say a grocery store is waiting for a banana delivery from another continent and pays for an exact number of bananas while expecting the same number upon arrival. Unfortunately, due to human error, some irregularities may occur. It could be possible that workers would have misplaced some bananas, lied about all the bananas making it to the final destination, or stole some off the line. Any party that does this can mess up the whole supply chain, and by the time the store receives the goods, so much would have gone wrong.
Using smart contracts, grocery stores could have designed an automated check-in at every step of the way. Even though these check-ins already exist in a typical supply chain, the difference is that they are done manually. With the manual process, you’ll need to have someone count the products and submit what was delivered. The bad side is that the person may be dishonest and decide to take some of the products, claiming that some were lost along the way. And just so you know, supply chain theft is a serious problem, especially in the U.S., where businesses lose $35 billion a year.
What makes smart contracts different is the trustless aspect. Using a smart contract, a grocery store can tweak things so that payment is only released after all bananas are accounted for. Thanks to smart contracts, there is no way a single party can mislead the system. To this end, all parties involved will be more attentive when it comes to supply. More so, payments will be released instantly to the seller, which is an excellent incentive to keep doing better.
Another exciting aspect of deploying smart contracts to the supply chain process is that parties can easily trace which smart contracts aren’t being fulfilled and decide not to work with those parties. In the future, smart contracts will also be used to rate clients. This way, you’ll know which clients are best to work with and those who aren’t. At the end of the day, smart contracts being deployed to the supply chain process will save all parties involved time and money.
The not so cool aspects of smart contracts
Even though smart contracts are all shades of amazing in concept, they are still not perfect in the real sense. On the one hand, it’s always important to know that developers program smart contracts and blockchain networks. To this end, human error is possible. These errors can provide loopholes hackers can exploit. This is precisely what happened to the famous Decentralized Autonomous Organization (DAO) in 2016. Hackers leverage the vulnerability in DAO’s fundraising contract, using the opportunity to steal funds from the project.
Also, we would like to mention the lack of regulatory clarity that plays out when it comes to these agreements. Even though the idea of a secure and streamlined money transfer process looks great on paper, you’ll still need to factor in the issue of taxation and other government involvement. While users will want complete control of their data, what do government parties get in return?
Let us also quickly add that smart contracts aren’t able to pull information outside of the primary network, which they exist in. What we mean here is that you can’t upload data from, let’s say, an existing website to a smart contract on Ethereum. But not to worry, developers are now finding a workaround using oracles of chain nodes. This will enable users to pull information from the internet and make it compatible with blockchain networks. As the industry continues to advance, we expect that time will come when a database can be moved to the blockchain, and we expect oracles to make that happen soon.
It’s important also to remember that there is a lingering scalability issue to worry about. Since the inception of the blockchain network, there has always been a struggle to scale. What we mean here is that transactions can take minutes, if not hours, to complete. While this will no doubt be a problem right from the get-go, we expect Ethereum 2.0 to resolve the issue of scalability once and for all. Even with transactions taking hours to complete, it is still pretty much better than what’s obtainable when moving traditional funds.