What is Smart Contract? Complete Guide
- 1 How Does Smart Contract Work?
- 2 Main features
- 3 Can I Change or Delete a Smart Contract?
- 4 Advantages and Use Cases
- 5 Summary
- 6 Why are Smart Contracts Important?
- 7 Conclusion
The concept of a smart contract originated with Nick Szabo in the 90s. At the time, he defined a smart contract as a tool capable of making computer networks secure and formal by combining protocols with user interfaces. Szabo discussed the potential use of smart contracts in various fields involving contractual agreements — such as credit systems, payment processing, and copyright and content management.
in the world of moeda digital, we can define a smart contract as an application or program that runs on a block chain. Typically, they function as a digital agreement that is enforced with a specific set of rules. These rules are predefined by computer code, replicated and executed on all “nodes” of the network.
Basically, blockchain smart contracts allow the creation of trustless protocols (protocols that do not require a trusted third party). This means that two parties can make commitments on the block chain without having to know or trust each other.
There is a guarantee that if the conditions are not met, the contract will not be performed. Also, the use of smart contracts can overlook the need for middleman, significantly reducing operating costs.
While the Bitcoin protocol has supported smart contracts for many years, they have become more popular thanks to Ethereum creator and co-founder Vitalik Buterin. It is worth noting, however, that each block chain may have a different method of implementing smart contracts.
This article will cover smart contracts that work in the Ethereum Virtual Machine (EVM), which is a central part of the Ethereum block chain.
How Does Smart Contract Work?
In short, an intelligent contract works like a deterministic program. It performs a task individualizes when certain conditions are met. In other words, an intelligent contract system constantly follows the logic “if… then…”. But despite the terminology, smart contracts are not legal contracts, nor are they smart contracts. They are just a snippet of code running on a distributed system (blockchain).
In the Ethereum network, smart contracts are responsible for executing and managing blockchain operations, which occur when users (addresses) interact with each other. Any address that is not a smart contract is called an externally owned account (EOA). This means that smart contracts are controlled by computer code and EOAs are controlled by users.
Basically, Ethereum Smart Contracts are composed of a contract code and two public keys. The first public key is the one provided by the creator of the contract. The other key represents the contract itself, acting as a digital identifier that is unique to each smart contract.
The deployment of any smart contract is done through a block chain transaction and the contract can only be activated when called by an EOA account (or other smart contracts). However, the initial activator will always be an EOA (user).
Generally, a smart contract Ethereum (ETH) has the following characteristics:
Smart contracts are replicated and distributed across all nodes of the Ethereum network. This is one of the main differences from other centralized server-based solutions.
Smart contracts only perform the actions they are designed for, taking into account the requirements to be met. Furthermore, the result will always be the same regardless of who executes them.
Smart contracts can automate all kinds of tasks, acting as a self-running program. However, in most cases, if a smart contract is not triggered, it will remain “asleep” and take no action.
Smart contracts cannot be changed after implementation. They can only be “deleted” if a specific function has been previously implemented. In this way, we can say that smart contracts are able to provide tamper proof encryption.
Prior to implementation, smart contracts can be coded in many different ways. They can be used to create various types of decentralized applications (DApps). This feature is directly related to the fact that Ethereum is a complete Turing block chain.
Two or more parties can interact through smart contracts, without the need to know or trust each other. In addition, block chain technology ensures data accuracy.
Since smart contracts are based on a public block chain, the source code is not only immutable, it is also visible to anyone.
Can I Change or Delete a Smart Contract?
It is impossible to add new functions to an Ethereum smart contract once it has been implemented. However, if the creator includes a function called SELFDESTRUCT (self-destruct) in the code, it is possible to “erase” the smart contract in the future — and replace it with a new one. However, if the function is not included in the code in advance, it will not be possible to delete it.
So-called updatable smart contracts allow developers greater flexibility about the immutability of contracts. There are many ways to create updatable smart contracts, with varying degrees of complexity.
As an example, let's imagine that a smart contract is split into several smaller contracts. Some of them are designed to be immutable, while others have an “opt-out” function enabled. This means that part of the code (smart contracts) can be erased and replaced, while other functionality remains intact.
Advantages and Use Cases
Because they have programmable code, smart contracts are highly customizable and can be designed in many different ways, offering many types of services and solutions.
Because they are programs decentralized and self-executing, smart contracts can provide greater transparency and reduced operating costs. Depending on the implementation, they can also increase efficiency and reduce bureaucratic expenses.
Smart contracts are especially useful in situations involving the transfer or exchange of funds between two or more parties.
In other words, smart contracts can be designed for a wide variety of use cases. Some examples include creating symbolic assets, systems of voting, Cryptocurrency wallets, decentralized exchanges, games and mobile apps.
They can also be implemented alongside other block chains that are looking for solutions in the areas of healthcare, charity, supply chain, administration and decentralized finance (DeFi).
Tokens issued in the Ethereum blockchain follow a pattern known as ERC-20. The standard describes the fundamental functions of all tokens based on the Ethereum blockchain. In other words, these digital assets are often called ERC-20 tokens and represent a large part of existing Cryptocurrencies.
Many startups and blockchain companies have implemented smart contracts to issue their digital tokens on the Ethereum network. After issuance, most of these companies distributed their ERC-20 tokens through Initial Coin Offering (ICO) events.
In most cases, the use of smart contracts has allowed you to trade funds and distribute tokens reliably and efficiently.
Smart contracts are made by computer code created by humans. This brings with it some risks as the code is subject to vulnerabilities and bugs. In an ideal scenario, they should be written and used by experienced programmers, especially when they involve sensitive information or a lot of money.
Also, some justifying which centralized systems can provide most solutions and applicability offered by smart contracts. The main difference is that smart contracts run on a distributed P2P network rather than a centralized server. Furthermore, they are based on a block chain system and tend to be immutable or very difficult to change.
Being immutable can be a great trait in some situations, but very bad in others. For example, when a decentralized autonomous organization (DAO) called “The DAO” was invaded in 2016, millions of étheres (ETH) were stolen due to flaws in the smart contract code.
Since the smart contract was immutable, the developers were unable to fix the code issue. This ended up resulting in a hard fork, which gave rise to a second chain of Ethereum. Simply put, one part of the chain “rolled back” the hacker's action and returned the funds to their respective owners (this is part of the current Ethereum block chain).
The other part of the chain decided not to interfere with the consequences of the attack, stating that what happens in a block chain should never be changed (this is the current Ethereum Classic block chain).
It is important to note that the problem did not originate in the Ethereum blockchain. It was caused by a clever and faulty implementation of the contract.
Another limitation of smart contracts is related to their uncertain legal status. Not only because it is part of an underexploited area in most countries, but also because smart contracts do not yet fit into the current legal framework.
For example, many contracts require both parties to be properly identified and over the age of 18: the anonymity provided by block chain technology, coupled with the lack of intermediaries, can compromise these requirements.
While there are potential solutions for this, the legal enforcement of smart contracts is a real challenge — especially when it comes to borderless and distributed networks.
Some blockchain enthusiasts see smart contracts as a solution that will soon replace and automate much of our business and bureaucratic systems. While this is a possible reality, it is probably far from happening.
Smart contracts are surely a technology thought-provoking. However, because they are distributed, deterministic, transparent and somewhat immutable, they can be less attractive in some situations.
Essentially, the criticism is based on the fact that smart contracts are not an adequate solution to many real problems. In fact, for some organizations it is much more convenient to use conventional server-based alternatives.
Compared to smart contracts, centralized servers are cheaper and easier to maintain. Furthermore, they tend to be more efficient in terms of speed and communication across networks (interoperability).
Smart contract, like any other contract, sets the terms of an agreement. But unlike a traditional contract, the terms of a smart contract are executed as code running in a chain of blocks, like Ethereum (ETH). Smart contracts allow developers to build applications that benefit from the security, reliability, and accessibility of the block chain, offering sophisticated functionality peer-to-peer in everything from loans and insurance to logistics and gaming.
Why are Smart Contracts Important?
Smart contracts allow developers to create a wide variety of decentralized applications and tokens. They are used in everything from new tools financial even logistics and gaming experiences, and are stored in a blockchain like any other cryptocurrency transaction. Once a smart contract application is added to the blockchain, it generally cannot be rolled back or changed (although there are exceptions).
Contract-based smart applications are often referred to as “decentralized applications” or “dapps” and include decentralized finance technology (or DeFi) designed to transform the banking industry.
DeFi applications allow holders of cryptographic currency to perform transactions complex financial (savings, loans, insurance) without the intervention of a bank or other financial institution and from anywhere in the world. Some of the most popular contract-based smart apps today include:
Uniswap: decentralized exchange that allows users, through an intelligent contract, to transact certain types of cryptographic coins without any central authority setting exchange rates.
compound: platform that uses smart contracts to allow investors to earn interest and those who need a loan to get it immediately without having to go to the bank.
USDC: cryptographic currency linked via a smart contract to the USD, which makes a USDC worth USD. USDC is part of a newer category of digital money known as stable currency currencies.
How would you then use these smart contract-based tools? Imagine that you have some Ethereum (ETH) that you would like to exchange for USDC. You could put some Ethereum on Uniswap, which, via smart contract, can immediately determine the best exchange rate, perform the transaction and send you your USDCs.
You could then put some of your USDCs into Compound to lend to others and receive an algorithmically determined interest rate, without ever going to the bank or other financial institution.
In traditional finance, currency exchange is expensive and time-consuming. And it's neither easy nor safe for people to borrow their assets liquids to strangers on the other side of the world. But smart contracts make these and many other scenarios possible.
There is no doubt that smart contracts have had a huge impact on the world of cryptocurrencies and have certainly revolutionized the block chain environment. Although end users may not directly interact with smart contracts, it is likely that they will serve a wide range of applications in the future since financial services to supply chain management.
Smart contracts, together with block chain technology, have the potential to revolutionize almost every area of society. Only time will tell whether these innovative technologies will be able to overcome the many barriers that prevent large-scale adoption.
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