Today, the world of cryptocurrency and blockchain technology is unimaginable without smart contracts—self-executing contracts that help make the industry more transparent and automated.
In our new comprehensive guide, we will discover what smart contracts are, how they work, and how they are already being actively applied in various areas of our everyday life.
Introduction to smart contracts
Definition of smart contracts
Let’s start by answering the question: what are smart contracts? Simply put, smart contracts are programs with predefined conditions that they are designed to enforce. If we delve a little deeper into the technical language, the answer to what is a smart contract becomes slightly more complex: they are programmable bits of code that trigger pre-programmed actions only when a certain set of conditions is met.
At their core, they are fully analogous to real-world contracts, which is why smart contracts are often referred to as digital contracts. The only difference between the two is that real-world contracts are governed by law, while “smart” ones are governed by code.
What does a smart contract look like? Source: Hyperledger
History and evolution of smart contracts
Now that we have a basic understanding of what a smart contract is, let's dive a bit deeper into its origins.
The concept of smart contracts was first introduced in the early 1990s. It was developed by the renowned cryptographer Nick Szabo, who, as many believe, is the creator of Bitcoin. He proposed the idea of smart contracts back in 1994.
However, smart contracts didn’t become mainstream until the launch of the Ethereum cryptocurrency in 2015. The project solutions allowed developers to begin writing smart contracts for various applications using the Solidity programming language. Smart contracts gained a second wave of popularity with the rise of DeFi (Decentralised Finance).
Today, smart contracts are the backbone of almost all blockchain-related projects.
How smart contracts work
The technology behind smart contracts
To have smart contracts explained, we need to discuss the technology they rely on.
Technically, a smart contract is a piece of code into which a developer pre-programmes specific requirements. The foundation for any smart contract is the blockchain ledger. Each of these automated agreements is recorded on the blockchain, which ensures its security and immutability.
The execution of a smart contract happens automatically as soon as the predetermined conditions are met. This guarantees that neither party can alter the terms once the execution has begun.
Key components of a smart contract
Despite the seemingly complex nature of the technology, only a few key components are required for a smart contract to function. Here they are:
1. Participants. These are the parties who interact with one another through the smart contract. There must be at least two participants, but there could be more.
2. Conditions. Once participants have found one another, they agree on the terms of the transaction. At this stage, clearly defined rules are established, which the contract will automatically execute when fulfilled.
3. Code. All necessary rules and conditions of the transaction are represented in the form of code which will drive the smart contract’s operation.
4. Blockchain. Smart contracts only operate on blockchains, so participants must also choose a suitable option from available smart contract platforms. We will discuss these in more detail later.
5. Transaction execution. Once all the predefined conditions are fulfilled, the code initiates the transaction — whether it's a transfer of funds or a change in document status.
This process is fully automated and irreversible. There is no possibility of external or internal interference, nor is there any chance of undoing the actions taken.
Benefits of smart contracts
Smart contracts are undeniably a technology that simplifies life for many people around the world and significantly improves various areas of daily life. Let’s explore the key advantages of this type of peer-to-peer agreements.
1. Security and trust. Thanks to the unique properties of blockchain technology, participants in a transaction can maintain complete anonymity. Moreover, a smart contract cannot be altered or deleted. This greatly reduces risks associated with fraud.
2. Efficiency and speed. Moving agreements into the digital space accelerates document flow and makes the process simpler. Where traditional contracts might take days or weeks to review and finalise, a smart contract executes instantly as soon as the conditions are met.
3. Cost-effectiveness. With smart contracts, there is no longer a need for intermediaries such as lawyers, banks, or exchanges. This significantly speeds up and reduces the cost of the process.
4. Transparency. Smart contracts make it possible to create a transparent system for monitoring contract terms. Additionally, all information regarding such transactions is recorded on blockchain networks. This means that the terms of the agreement cannot be altered retroactively, and participants, or even anyone else, can view the smart contract and its conditions at any time.
Challenges and limitations
While smart contract technology is undoubtedly innovative and beneficial, it does come with its own set of challenges. Let’s take a look at the most significant drawbacks:
1. Scalability issues. Since smart contracts operate on blockchain technology, they are affected by the specific limitations of blockchains themselves. The primary issue is scalability: as the network grows, the time it takes to process transactions and their cost can increase. This severely limits the potential use of such contracts. This phenomenon is widely known as the blockchain trilemma.
2. Security concerns. Although self-executing contracts offer a high level of security and sophistication, they are not entirely immune to errors. Incorrectly coded contracts could lead to financial losses for one or even all participants involved. In less severe cases, the contract might simply fail to execute correctly.
3. Legal and regulatory challenges. Currently, most countries around the world lack a clear legal framework for dealing with smart contracts. The absence of proper regulation poses a serious problem for market players who may not fully understand when they are operating outside the legal framework.
Popular smart contract platforms
By now, we’ve got a solid understanding of what is smart contracts. The final and equally important task is to explore which blockchain networks and smart contract platforms are available on the market today.
The Ethereum blockchain has firmly established itself as the leader in this space. The platform offers a well-developed infrastructure for developers and a wide range of tools for creating decentralised applications. As of today, Ethereum is deservedly considered the most popular platform for building smart contracts.
Ethereum official website
Binance Smart Chain is a relatively new platform that offers lower transaction fees and faster processing times.
BNB Chain official website
A standout feature of Polkadot is its interoperability with other networks, meaning that smart contracts built here can easily interact with other blockchains.
Polkadot official website
Cardano focuses on security and a scientific approach to development. Its architecture allows the creation of highly secure and efficient smart contracts.
Cardano official website
As for other notable platforms, it’s impossible not to mention Solana, Tezos, and Avalanche, which also offer unique solutions for creating smart contracts. Each of these platforms has its own features and is suitable for different types of projects.
Applications of smart contracts
There are practically no limits to what smart contracts can achieve. The range of applications for this technology is incredibly broad, spanning from logistics to healthcare. Here are just a few examples of how smart contracts can be utilised:
1. Decentralised Finance (DeFi) is one of the most promising areas for the application of smart contracts. In DeFi systems, smart contracts are used to provide financial services without the involvement of traditional banks. For example, they can be used for lending, asset exchanges, and investment management.
A notable example is from 2021, when the American financial conglomerate Goldman Sachs executed a repo transaction via JPMorgan’s blockchain network, supported by smart contracts. The technology helped both parties to secure the terms of the agreement and track the fulfilment of obligations.
2. Supply chain management is another area where smart contracts are used to automate logistics processes. They can track the movement of goods and automatically initiate payments upon receipt, improving efficiency and reducing risks.
3. Real estate transactions can also be automated using smart contracts. The technology eliminates the need for intermediaries and reduces the risk of errors. The sale and transfer of property rights can thus be conducted as a peer-to-peer agreement.
4. In voting systems, smart contracts can ensure transparent and secure voting processes. Thanks to their decentralised nature, the results cannot be tampered with, making the process more democratic.
5. As for insurance and healthcare, the technology can automatically issue payouts in the event of an insurance claim. In healthcare, smart contracts can be used for storing and processing medical records, enhancing security and accessibility.
Frequently Asked Questions (FAQ)
What is a smart contract? A smart contract is a self-executing program with predefined conditions that automatically enforces the terms of an agreement. It is similar to a traditional contract, but instead of being governed by law, it is governed by code on the blockchain.
How do smart contracts work? Smart contracts are written in code and stored on a blockchain. Once the predefined conditions are met, the contract automatically executes the agreed-upon actions, such as transferring funds or updating records, without the need for intermediaries.
What are the benefits of using smart contracts? Smart contracts offer increased security, efficiency, and transparency. They eliminate the need for intermediaries, reduce costs, and ensure that the contract’s terms cannot be altered or tampered with once recorded on the blockchain.
What are the main platforms for smart contracts? The most popular platform for smart contracts is Ethereum, but other notable platforms include Binance Smart Chain, Polkadot, Cardano, and Solana. Each platform has its own unique features and advantages for different types of projects.
Conclusion: the future of smart contracts
Smart contracts are a relatively young technology, but they have already carved out their niches in modern society. The technology automates, accelerates, and simplifies many processes related to digital transactions for users.
Speaking of emerging trends, we can expect that the application of smart contracts will continue to expand in the future. For example, their use could grow in areas such as education.
Developers are constantly improving blockchain technology and smart contracts that run on it. In light of this, it’s likely that, over time, we will witness significant innovations in smart contract technology. One of the key developments will be enhanced interoperability between different blockchains, which will open up new opportunities for creating hybrid solutions.
As for the potential impact on various industries, smart contracts hold enormous potential — they could find new applications in fields ranging from finance to the management of entire governments.
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This article is not investment advice or a recommendation to purchase any specific product or service. The financial transactions mentioned in the article are not a guide to action. It’s not intended to constitute a comprehensive statement of all possible risks. You should independently conduct an analysis on the basis of which it will be possible to draw conclusions and make decisions about making any operations with cryptocurrency.
