What are smart contracts?
Like any other contract, a smart contract specifies the conditions of a deal. However, in contrast to a conventional contract, the rules of a smart contract are carried out as code that runs on a blockchain like Ethereum. Developers may create sophisticated peer-to-peer functionality into their apps using smart contracts, leveraging the security, dependability, and accessibility of the blockchain for everything from lending and insurance to logistics and gaming.
Smart contracts define the parameters of an agreement or deal, just like any other contract. But what makes them “smart” is that the terms are decided upon and carried out as code running on a blockchain, as opposed to on paper on a lawyer’s desk. Smart contracts build on the fundamental concept of Bitcoin, which is to send and receive money without a “trusted intermediary” like a bank in the middle, to enable the decentralized automation of nearly any agreement or transaction, regardless of how complex it may be. Additionally, they provide security, dependability, and accessibility without boundaries because they are built on a blockchain like Ethereum.
What makes smart contracts so crucial?
Decentralized apps and currencies of all shapes and sizes can be created by developers using smart contracts. They are maintained on a blockchain like any other cryptocurrency transaction and are used in everything from new financial tools to logistics and gaming experiences. A smart-contract app is often irreversible once it is added to the blockchain (although there are some exceptions).
Decentralized applications, often known as “dapps,” are applications driven by smart contracts and contain decentralized financial technology (also known as DeFi), which aspires to revolutionize the banking sector. DeFi apps enable cryptocurrency owners to conduct complicated financial activities, including as saving, borrowing, and insurance, from anywhere in the globe without a bank or other financial institution getting a cut. Current apps that use smart contracts and are more widely used include:
- Uniswap: A decentralized exchange that lets users trade certain types of cryptocurrency using smart contracts without any central body controlling exchange rates.
- Compound: A platform that utilizes smart contracts to enable borrowers to receive loans promptly and investors to earn interest without the need for a bank to act as a middleman.
- USDC: A cryptocurrency that is linked to the US dollar via a smart contract, making one USDC equal to one USD. Stablecoins, a more recent subset of digital currency, include UDDC.
So, how would you use these technologies that are enabled by smart contracts? Consider that you have some Ethereum that you would like to exchange for USDC. Put some Ethereum into Uniswap, which will use a smart contract to automatically locate you the best exchange rate, execute the deal, and pay you your USDC. Then, without utilizing a bank or other financial institution, you might put part of your USDC into Compound to lend to others and obtain an algorithmically set rate of interest.
Currency exchanges in conventional finance are pricy and time-consuming. Additionally, lending liquid assets to total strangers on the other side of the globe is neither simple nor secure for individuals to do. But all of those scenarios—as well as a wide range of others—are made conceivable by smart contracts.
How do smart contracts work?
The idea for smart contracts was first put forth in the 1990s by Nick Szabo, a lawyer and computer scientist. Famously, Szabo likened a smart contract to an automated soda dispenser. Think of a machine that offers Coke cans for sale for one quarter. If you put a dollar in the machine and choose a soda, the system is hardwired to either provide the soda and 75 cents in change, or (if the soda of your choice is sold out) to encourage you to choose another soda or get your $1 back. An example of a straightforward smart contract is this. Smart contracts can automate almost any type of exchange, much the way a Coke machine can do it without a human middleman..
The most widely used smart contract platform at the moment is Ethereum, however several other cryptocurrency blockchains (including EOS, Neo, Tezos, Tron, Polkadot, and Algorand) are also capable of supporting them. Anyone may design and deploy a smart contract to a blockchain. Any interested party may view its code, which is open and publicly verifiable, to determine exactly what logic a smart contract employs when it gets digital assets.
- Many different programming languages are used to create smart contracts (including Solidity, Web Assembly, and Michelson). Each smart contract on the Ethereum network has its code stored on the blockchain, enabling anybody with an interest to examine the contract’s code and current state to confirm its operation.
- Along with the blockchain and transaction data, every computer on the network (or “node”) keeps a copy of all active smart contracts and their current state.
- All nodes in the network execute a smart contract’s code when it receives money from a user in order to agree on the result and value flow that results. Because of this, smart contracts may operate safely without the need for a centralized authority, even when users conduct intricate financial transactions with unidentified parties.
- On the Ethereum network, you often have to pay a charge called “gas” to execute a smart contract (thus named because the payments pay for maintaining the blockchain).
- Smart contracts are often unchangeable once they are put into use on a blockchain, not even by their inventor (this rule is not always applicable). This makes it more difficult for them to be blocked or restricted.