What is a smart contract?
A smart contract is a decentralized computer program running on a blockchain network that decides to implement or execute an agreement based on its own on certain conditions. In other words, all smart contracts have rules that specify predetermined conditions and the occurrence of the same triggers the outcome of formation of a contract if fulfilled.
Smart contracts operate on a decentralized blockchain rather than a central server, allowing multiple parties to receive shared results in a real, timely and tamper-proof manner. However, smart contracts are “smart” because the content is created and executed as code running on the blockchain, not on paper.
Like all contracts, a smart contract also establishes the terms of an agreement. However, unlike traditional contracts, the terms of a smart contract are executed as program code running on a blockchain such as Ethereum. Smart contracts allow developers to create applications that deliver complex peer-to-peer everything from rentals and insurance to transportation and entertainment, while increasing the security, reliability, and accessibility of the blockchain.
The idea of self-executing agreement, free from intermediaries and bureaucracy, has long tantalized legal and technological minds. Today, with the emergence of blockchain technology, this vision is brought to life through a smart contract. These digital agreements, stored and processed in a ledger, are revolutionizing the way we shop, interact and trust each other in a decentralized world.
History of Smart Contracts
The seeds of smart contracts were sown in the 1990s. Legal expert and computer scientist Nick Szabo discovered “digital agreements” in 1996, which introduced concepts such as privacy and data immobility. In 1998, BitTorrent pioneer Bram Cohen proposed “financial machines” code-governed agreements for digital cash. But these ideas do not have necessary infrastructure.
Bitcoin’s arrival in 2009 changed the game. Blockchain, a distributed ledger that enables transparent and permanent recording of transactions, provides the perfect platform for these self-executing agreements. In 2013, Vitalik Buterin built Ethereum, a blockchain specifically designed for smart contracts allowing sophisticated functions and complex agreements.
Early applications like Augur’s decentralized prediction markets and DAO (Decentralized Autonomous Organization) experiments showcased the potential. Though fraught with challenges like code vulnerabilities and legal uncertainties, the technology matured. Enterprise solutions emerged for supply chain management and cross-border transactions. DeFi applications like Uniswap and Aave democratized finance.
Stages involved in formation of a smart contract
- Defining the Contract: This is the most important step because it involves clearly outlining the terms and conditions of the contract in a way that can be translated into programming code. This includes identifying the involved parties, their roles and responsibilities, the reason for the contract, and the expected results.
- Choosing a Blockchain Platform: Different blockchains have different features and functionality, so it is important to choose a blockchain platform that meets one’s specific needs from a smart contract. Key factors to consider include platform security, scalability, transaction costs, and developer community support.
- Developing the Smart Contract Code: This step involves expertise in blockchain development and smart contract programming languages like Solidity for Ethereum or Vyper for Ethereum. Code should be carefully written, tested, and reviewed to ensure it works as intended and is error-free.
- Deploying the Smart Contract: Once the code is finished, it’s uploaded and deployed to one’s preferred blockchain platform. This is usually to pay transaction fees to miners or network users.
- Interaction with the Smart Contract: Once published, smart contracts become an immutable part of the blockchain. Users can interact with it by triggering its execution through transactions that meet the predefined conditions. These transactions are also recorded on the blockchain, making it transparent and immutable.
Types of smart contracts
- Smart legal contracts
Smart legal contract is a blockchain-based evolution of traditional legal contracts. It enables automatic execution and verification of legal agreements.These types of smart contracts are particularly relevant in the legal and real estate sectors where trust and compliance are important. For example, smart legal contracts can be used to facilitate real estate transactions, allowing payments to be transferred directly to property owners when received. A smart legal contract is more than words on paper. It’s a self-executing code on a secure blockchain that automatically triggers an agreed upon action in the event of an incident. There are no middlemen, no delays, just continuous work from “if” to “then”. It is meant to be like a digital vending machine but with complex processes. It builds trust through tamper-proofing and transparency, but the legal system is still trying to catch up. It can be efficient in Real estate, finance, chain and other industries but there are errors, gray laws, loopholes that can be misused.
- Decentralized Autonomous Organization
Decentralized Autonomous Organization, commonly known as DAO, is a special type of smart contract that goes beyond traditional contracts. The DAO is essentially an automated organization run by code and governed by token holders. They enable shared decision-making and financial management without a central authority. An example of a DAO is an investment community where participants vote on investment decisions and smart contracts execute the decisions made independently. DAOs in other words are democratic groups governed by a smart contract that gives them voting rights. DAO is a blockchain-based organization with a common purpose. There is no manager or president, instead blockchain-based principles in the contract govern how the organization operates and how funds are distributed. VitaDAO is an example of such smart contracts where the technology powers a community for scientific research.
- Application logic contracts (ALC)
An Application Logic Contract is a smart contract designed to perform a specific task or process within decentralized applications (DApps). These agreements govern the core content, functionality and operation of DApps, ensuring they are efficient and independent. For example, in a gambling application, ALC can manage gambling bets, payment and number generation without human intervention. ALCs, or application logic contracts, that consist of an application code. These codes are often synchronized with many other blockchain contracts. It supports the interaction of various devices, such as Internet of Things (IoT) or blockchain integration. Unlike other types of smart contracts, these contracts are signed not by individuals or organizations, but by machines and other contracts.
Benefits of Smart Contracts
- Enhanced Efficiency and Automation: No more paperwork or manual work. Smart contracts execute contracts automatically, saving time and reducing errors. Eliminate the middleman and its associated costs. Transactions are made directly between two parties, saving costs and making transactions happen faster.
- Increased Transparency and Trust: All commitments and implementation steps are secured in the blockchain and accessible to all participants. The change in policy ensures that data is tamper-proof, increasing trust and reducing the risk of fraud.
- Reduced Risk and Error: Predefined events automate tasks, eliminating human error and potential conflicts. Secure encryption technology protects sensitive and business data from unauthorized access.
- Global Accessibility and Inclusivity: Anyone with an internet connection can participate in smart contracts, regardless of location or financial situation. Decentralization eliminates the geographical problem and allows people to manage their own assets and information.
- New Opportunities and Innovation: Smart contracts enable new partnerships and efficient exchanges, enabling new partnerships and efficient exchanges in finance, management supply chain, management, etc. It opens the door to new applications in different fields. Programmable money from tokens opens up new possibilities for fundraising, ownership and distribution of wealth.
Limitations of Smart Contract
- Complexity and Expertise: Writing secure and reliable smart contracts requires strong coding skills and expertise in blockchain technology. Not everyone has this skill, which can limit its accessibility and increase development costs.
- Vulnerability to Bugs and Hacks: Program code may contain bugs or vulnerabilities. Hackers can use these weaknesses to control the execution of contracts, resulting in inefficiency and financial losses.
- Legal Uncertainties: The legal framework surrounding smart contracts is still evolving. In some aspects issues such as management, responsibility and solution are not clear, creating confusion for users.
- Scalability Limitations: Current blockchain technology may have difficulty handling large transactions, making transaction time slow and expensive. This becomes a deterrent to adoption, especially for complex applications.
- Limited Functionality: Smart contracts are currently best suited for formal agreements with clearly defined terms. They may struggle with situations that require decision making, change, or human intervention.
- Lack of Standardization: Different blockchains have different standards and specifications for smart contracts, making it difficult to create mutually exclusive contracts across multiple systems.
- Environmental Impact: Depending on the specific blockchain used, smart contracts can consume a lot of energy and raise concerns about security rounds.
Conclusion
It is important to remember that smart contract technology is still in the early stages of development. Continuous research and innovation solves these problems and advances in areas such as code security, regulations, problem solving, interface standards.
Smart contracts represent a revolution in the way we believe in and interact with the digital world. Their ability to streamline complex processes, eliminate intermediaries, and increase transparency goes beyond finance and technology. As technology grows and problems are solved, we expect to see an explosion of new applications, expansion of reliability, efficiency, and empowerment across a variety of industries.
The potential of smart contracts is huge, and its impact on the way we live, work and interact is not yet fully understood. As we navigate the uncharted waters of this future, encouraging innovation while addressing responsible challenges will be key to unlocking the full potential of self-regulating processes and creating a world of transparency, participation and trust.
Written by: Swetha SS
