Smart contracts are digital contracts stored on the blockchain that automatically execute when certain conditions are met. They can be envisioned as self-operating programs that ensure transactions and agreements are fulfilled without the need for an intermediary. Once the contract terms are met, the system automatically triggers and executes the agreement.
In the Web3 space, smart contracts play a crucial role like pollen in nature – though often unnoticed, they are essential for the development and operation of the new generation of the Internet.
Every time a peer-to-peer transaction is executed on a cryptocurrency exchange, smart contracts take on the processing role without the need for intermediaries. When you purchase digital artwork on NFT marketplaces like OpenSea, smart contracts validate the transaction and transfer ownership to you. Or when participating in a decentralized finance (DeFi) protocol to borrow or lend, smart contracts automatically execute the terms of the loan.
In reality, you can easily interact with the Web3 space without needing to understand how these code snippets work. However, if you are reading this, you must be starting to become curious about the underlying platform of these digital transactions.
Understanding Smart Contracts
Smart contracts are automated contracts stored on the blockchain that self-execute when predefined conditions are met, eliminating the need for intermediaries. They can be viewed as self-operating digital agreements that ensure transactions are completed as promised.
This automation helps reduce costs, speeds up processing, and limits human error.
For example, when you buy a car online, a smart contract can be set up to transfer ownership and disburse payment after both the buyer and seller have fully fulfilled their obligations under the agreement.
When the seller uploads proof of delivery, the smart contract will verify this information, subsequently disbursing payment to the seller and simultaneously updating the vehicle ownership records for the buyer. This process enables smooth and reliable transactions without third-party intervention.
How Smart Contracts Work
Smart contracts operate based on simple statements of 'if/when... then...'. Specifically, when a certain condition is met, the contract will automatically execute the agreed-upon action.
Imagine a vending machine: you put in a coin (the condition is met), and the machine dispenses a snack (the action is performed). Smart contracts work similarly but in a digital environment. For example, when you send a certain amount of cryptocurrency to a smart contract, the contract will automatically transfer a digital asset, such as a token, to your account.
Blockchain plays a critical role in this process, functioning as a decentralized ledger that records all transactions transparently and securely. When smart contracts are created, they will be stored on the blockchain.
Once conditions are met, the blockchain will verify and record the transaction, ensuring transparency and immutability. As a result, all participants can trust that the contract will be executed as programmed, without the need for intermediaries or any centralized regulatory authority.
History of Smart Contracts
The concept of smart contracts has an interesting history spanning decades and has significantly developed thanks to advances in blockchain technology.
Nick Szabo's idea: In 1994, Nick Szabo, a computer scientist and legal expert, first introduced the idea of smart contracts. He envisioned using software to automatically execute contractual agreements, eliminating the need for intermediaries. Szabo's idea was groundbreaking by proposing that digital code could manage and enforce contract terms similarly to how a vending machine dispenses products when the user inputs the correct amount.
The birth of Bitcoin: In 2008, Bitcoin emerged by an anonymous individual or group under the name Satoshi Nakamoto, laying the foundation for blockchain technology. Bitcoin's blockchain demonstrated the ability to operate a decentralized and immutable ledger, paving the way for more complex applications such as smart contracts.
Ethereum Proposal: In 2013, Vitalik Buterin, a young programmer, proposed the Ethereum platform – a new blockchain specifically designed to support smart contracts. Buterin's vision was to create a decentralized platform where developers could build and execute complex applications beyond conventional financial transactions.
Launch of Ethereum: In 2015, Ethereum officially launched alongside its own cryptocurrency, Ether, and a platform capable of executing smart contracts. This was a significant milestone, as Ethereum's blockchain allowed for the execution of smart code, creating decentralized applications (DApps). This innovation opened up many potentials for fields like finance, real estate, and supply chain management.
ICO Boom: In 2017, the boom of initial coin offerings (ICOs) showcased the potential of smart contracts. Startups leveraged the Ethereum platform to issue tokens and raise funds through digital assets. Smart contracts ensured that funds were only disbursed when specific conditions were met, creating transparency and trust in the fundraising process.
DeFi and NFT: From 2020 onwards, smart contracts became the foundation for the development of DeFi and NFTs. DeFi applications use smart contracts to create decentralized financial tools like lending platforms and decentralized exchanges. Meanwhile, NFTs – unique digital assets representing ownership of art, collectibles, and many other types of assets – also rely on smart contracts to ensure provenance and authenticity.
Today, smart contracts continue to evolve with research aimed at improving performance, security, and scalability. They remain a cornerstone of blockchain technology, driving innovations across many fields and changing how we manage digital agreements.
Applications of Smart Contracts
Smart contracts are reshaping many industries globally thanks to their ability to automate processes, enhance transparency, and reduce the need for intermediaries.
Decentralized Finance (DeFi)
DeFi is one of the most important applications of smart contracts. DeFi platforms use smart contracts to create financial tools like lending, borrowing, and trading without the need for traditional banks.
For example: Uniswap is a decentralized exchange (DEX) that allows users to trade cryptocurrencies directly from their personal wallets through smart contracts, without intermediaries.
Supply Chain
Smart contracts help improve transparency and efficiency in supply chain management. They can track goods from production to delivery, ensuring that all stakeholders have access to accurate information in real time.
For example: IBM’s Food Trust uses smart contracts to track the journey of food products. This system helps ensure food safety by quickly identifying sources of contamination and ensuring compliance with regulations.
Real estate
Smart contracts can simplify and secure transactions in real estate, from buying and selling assets to lease agreements. Smart contracts ensure that conditions such as payments and ownership transfers are met before the transaction is completed.
For example: Propy is a real estate platform that uses smart contracts to carry out buying and selling transactions. Buyers and sellers can complete transactions online, with documents and payments processed automatically through smart contracts.
Healthcare
In the healthcare sector, smart contracts help simplify processes such as managing patient consent, sharing data, and resolving insurance claims. They ensure that sensitive information is only accessible to authorized parties and handle insurance requests promptly.
For example: The MedRec project uses smart contracts to manage patient records, allowing patients to control data access, enhancing security and privacy.
Insurance
Smart contracts help automate the insurance claim processing, reducing the time and costs involved. Smart contracts can automatically verify claims and pay insurance according to predefined criteria.
For example: Etherisc is a decentralized insurance platform that uses smart contracts to provide flight delay insurance. If a flight is delayed, the smart contract automatically pays the insurance amount to the passenger.
Gaming
Smart contracts also play an important role in the gaming industry, helping manage in-game assets and ensuring fairness. They allow players to truly own digital assets and trade or sell them outside the game.
Axie Infinity is a prominent example, using smart contracts to manage assets and the in-game economy. Players can own, trade, and breed digital pets (Axies), with every transaction secured and executed through smart contracts.
Benefits of Smart Contracts
The outstanding benefits that smart contracts bring to the industries mentioned are key to their success. Here are some important benefits:
Speed and efficiency: Smart contracts automatically execute as soon as conditions are met, eliminating the need for manual processing. This helps speed up transactions and minimize delays.
Accuracy: Because smart contracts are operated digitally and automatically, they minimize errors compared to manual processing. The terms and conditions are executed exactly as programmed, ensuring precision in every transaction.
Trust and transparency: Smart contracts are stored on the blockchain with characteristics of transparency and immutability. All participating parties can view the contract and trust that it will be executed as agreed, with no hidden clauses or unexpected changes.
Security: Blockchain technology secures smart contracts, making them difficult to forge or defraud. Once a contract is recorded, it cannot be changed, creating a safe transaction environment for the parties involved.
Cost reduction: By eliminating intermediaries like brokers, lawyers, and banks, smart contracts help reduce costs compared to traditional contracts. This streamlined process also shortens the time needed to complete transactions.
Challenges and Limitations of Smart Contracts
While offering many benefits, smart contracts also face numerous challenges and limitations that hinder their widespread adoption in the short term.
Immutability: Smart contracts cannot be easily changed once deployed on the blockchain. This immutability ensures safety, but it also means that any errors in the contract code will persist indefinitely, and fixing them can be very costly.
Precise coding requirements: Smart contracts rely heavily on accurate programming. If there are errors or bugs in the code, the contract may produce undesirable results. The contract will execute exactly as coded, which becomes an issue if the code is incomplete.
Security vulnerabilities: Although blockchain technology is highly secure, smart contracts themselves can have vulnerabilities. Hackers may exploit these weaknesses, leading to significant financial losses. Therefore, regular testing and auditing of contracts are essential to mitigate risks.
Dependence on the programmer's skill level: The success of smart contracts depends on the skills and knowledge of the programmers. Poorly written contracts may not function as expected, highlighting the importance of having experienced and reliable developers.
Despite their potential, smart contracts require careful consideration of these challenges. Therefore, their application roadmap is likely to unfold slowly and steadily, rather than experiencing a breakthrough overnight.
The Future of Smart Contracts
The future of smart contracts is opening up many positive prospects.
With the development of technology, we can expect increasingly sophisticated and user-friendly tools for creating and managing smart contracts. Enhanced security measures and coding standards will be implemented to minimize vulnerabilities and enhance the reliability of smart contracts.
As seen, smart contracts have made a strong impact in the fields of finance, supply chain, real estate, healthcare, insurance, and gaming. As their benefits become more widely recognized, adoption is expected to spread to many other industries. For example, governments can use smart contracts to develop transparent voting systems, while businesses can automate complex compliance processes.
With high flexibility, smart contracts can be tailored for various purposes. We can see them integrated into Internet of Things (IoT) devices for automatic maintenance and repairs, or applied in managing intellectual property rights to handle royalties and licensing.
The future of smart contracts is promising with countless new application possibilities continuously expanding.
