In the world of cryptocurrency, decentralization is an important factor. An agreement between two parties must be executed and approved only by those two parties and no other entity involved. This idea can only be realized by the implementation of smart contracts that run on the blockchain network. Smart contracts on the blockchain network allows the creation of trustless protocols or trustless agreements. This allows two parties to make commitments with the blockchain’s smart contract without having to know each other and do not require trusted parties.
In traditional finance, an agreement between two parties regarding certain deals or services requires additional parties as intermediary and act as a testifier for the deals. This testifier is being called as a trusted party. Without the trusted party there are potential risks that one of the parties bound to the agreement will act fraudulently. This way makes the presence of the trusted parties essential for traditional finance’s agreements.
Smart contract terms were published by Nick Szabo, a computer scientist back in 1994, long before Bitcoin was created. Szabo describes smart contract as “a set of promises, specified in digital form, including the protocols within which the parties perform on the other promises.”
To simplify the terms of smart contracts coined by Nick Szabo, smart contracts is a self-executing contract between two parties or more which is written into lines of a computer code. The contract itself exists and is executed across decentralized blockchain networks. The contract is written in typical computer programming languages in the form of <if> and <then> commands.
A ‘smart’ term given by the nature of the contract which is written and automatically executed within the blockchain networks. It then becomes a smart contracts, the only agreements, deals and contracts which run automatically.
How Smart Contract Works?
Nick Szabo first illustrates the operations of a smart contract this way. If you put $1 into the machine, then it gives you a snack. The entire transaction is predetermined by the snack machine’s programming code without external influences. Smart contracts are designed to automatically execute functions in the same way.
<if money given into the machine> + <then certain snack selected>
= snack dispensed from the machine
A smart contract is like a vending machine, has logic programmed into it. In simple terms, it executes a particular or predetermined task when and if certain conditions are met.
On the Ethereum network, smart contracts are a type of Ethereum account or addresses, they can hold funds and can be the target of a transaction. The difference is this account is not controlled by a user, in fact they are deployed into the blockchain and run as programmed. Ethereum users can interact with certain smart contracts by requesting transactions that execute predetermined functions on the smart contract.
A smart contract, despite its popular terminology, are not a legal contract. It is only a piece of code running on a distributed network (blockchain).
Smart Contract Use Cases
So far, there are 1,5 million smart contracts being deployed on Ethereum blockchain only.
In reality, smart contract use cases can vary from sector to sector depending on where users are using them.
1. Trading Activity
This use case is proven by the creation decentralized exchange (DEX), where users can trade assets directly with smart contract protocols without the need for intermediaries
2. Financial Service
Allows human error-free financial services, automating many financial processes. This use case is proven by the creation of Decentralized Finance (DeFi) protocols
3. Payment System
Using the smart contracts means using the crypto assets within certain blockchain, the crypto assets itself is transferable to cross-border payment
4. Data Recording
Smart contracts activities are trackable within the blockchains, means that improves data recording, accuracy while optimize the reporting and auditing costs
Although not yet being implemented, smart contracts can help automate government operations while improving its transparency and efficiency
6. Supply Chain Management
Automates supply chain and improves transparency, which may reduce frauds
Automates insurances claims
Allows medical institutions to automate data share of certain clinical tests and improves privacy by removing any trusted parties
Automate escrow amount, authenticates transactions and automate trusts
10. Real-estate System
Automates mortgage, while increase approval and payments process
Smart Contract Limitations
The functionality of smart contracts are limited by how the code was written into it. Any kind of changing the parameter after the contract deployed on the blockchain cannot be executed. This is why a lot of smart contract protocols doing several updates in order to improves the contract capabilities
Smart contracts are still written by humans, although executed automatically depends on its code. This poses potential threats of computer bugs and vulnerabilities. A computer programmer expert is very required person to write the codes before the smart contract deployed to the masses.
- Require Real-World Data
Smart contracts just like another blockchains are isolated on their own. In order to execute certain contracts, it still requires real world information, like the value of US Dollar, a stock price, or real world location. This can be solve with third-party oracle technology which brings the real-world information into the blockchain using off-chain data.
- Uncertain Legal Status
Using smart contracts does not mean that the agreement is settled by legal regulation. In fact, smart contracts are still in the gray area for their legal status. Also most countries views smart contracts as a economy threat which not following the economy legal framework from certain countries
Smart Contract Advantages
|Trustless and transparent
Smart contracts can be executed without the need for third-party and all of the contracts are written and recorded within the distributed network (the blockchains). This removes the need for lawyers and financial institutions in most cases and also simplifies the agreements between two people or more who initially engaged the agreements.
After being deployed within the blockchain, a smart contract is a permanent term and cannot be changed or altered.
Smart contracts protocol’s code is open-source, meaning anyone can call or recreate the smart contract with various improvements and tweaks. A smart contract developer can fork another smart contract code and tweak the code with their own predetermined conditions.
Smart contracts are executed automatically and require no paperwork. This increases the operation speed and greatly reduces any costs needed by removing all the unnecessary third parties.
Smart contracts are a core building block of decentralized applications and definitely caused a big impact in the cryptocurrency world and blockchain space. Smart contracts will power a wide range of applications in the future, ranging from financial services to supply chain management and to many other areas.