What are Smart Contracts?

The Ethereum network relies heavily on smart contracts. Learn more about this amazing technology and why it has the potential to be revolutionary by clicking here.

Introduction

Smart contracts were initially defined in the 1990s by Nick Szabo. He described a smart contract back then as a mechanism for formalising and securing computer networks through the use of protocols and user interfaces.

Szabo explained how smart contracts may be used in a variety of industries involving contractual agreements, including credit systems, payment processing, and content rights management.

A smart contract is an application or software that operates on a blockchain in the realm of cryptocurrency. Typically, they function as a digital agreement governed by a set of rules. Computer code defines these rules, which are duplicated and performed by all network nodes.

Smart contracts on the blockchain enable the establishment of trustless systems. This means that two parties can create promises on the blockchain without knowing or trusting one another. They may be certain that if the terms aren't met, the deal will not be carried out. Aside from that, smart contracts can eliminate the need for middlemen, drastically lowering operating expenses.

Although the Bitcoin protocol has supported smart contracts for many years, they were popularised by Vitalik Buterin, the developer and co-founder of Ethereum. It's worth mentioning, though, that each blockchain may use a different approach to smart contract implementation.

How do they function?

A smart contract is a deterministic software in simple terms. When and if certain circumstances are satisfied, it performs a certain task. As a result, "if... then..." expressions are often used in smart contract systems. Smart contracts, contrary to common belief, are neither legal nor smart contracts. They are nothing more than a piece of code that runs on a distributed system (blockchain).

Smart contracts are in charge of performing and controlling blockchain actions that occur when users (addresses) engage with one another on the Ethereum network. An externally held account is any address that isn't a smart contract (EOA). EOAs are governed by users, whereas smart contracts are controlled by computer code.

Ethereum smart contracts are made up of two public keys and a contract code. The initial public key is that given by the contract's creator. The contract itself is represented by the other key, which serves as a digital identity for each smart contract.

Any smart contract must be deployed via a blockchain transaction, and they can only be executed when triggered by an EOA (or by other smart contracts). An EOA, on the other hand, is always the initial trigger (user).

Characteristics

The following are common properties of an Ethereum smart contract:

Distributed. The Ethereum network's smart contracts are duplicated and disseminated across all nodes. This is one of the primary distinctions from other centralised server-based systems.

Deterministic. Smart contracts only carry out the tasks for which they were created, as long as the conditions are satisfied. Furthermore, regardless of who implements them, the result will always be the same.

Autonomous. Smart contracts, which behave like a self-executing computer, may automate a wide range of operations. In most circumstances, though, if a smart contract isn't activated, it will remain "dormant" and do nothing.

Immutable. After they've been deployed, smart contracts can't be altered. Only if a certain function was previously implemented can they be "removed." As a result, smart contracts can provide tamper-resistant coding.

Customizable. Smart contracts can be coded in a variety of ways before being deployed. As a result, they may be utilised to build a variety of decentralised applications (DApps). This is due to Ethereum's status as a Turing complete blockchain.

Trustless. Smart contracts allow two or more parties to engage without knowing or trusting one other. Furthermore, blockchain technology assures data accuracy.

Transparent. Because smart contracts are built on a public blockchain, their source code is not only immutable but also public.

Is it possible to edit or remove a smart contract?

After an Ethereum smart contract has been launched, it is hard to add additional functionalities. If the smart contract's developer includes a function called SELFDESTRUCT in the code, they will be able to "destroy" it in the future and replace it with a new one. They won't be able to delete the method, though, if it isn't included in the code earlier.

Notably, so-called upgradeable smart contracts provide developers additional control over the immutability of contracts. Upgradeable smart contracts may be created in a variety of methods, each with differing degrees of difficulty.

Let's pretend that a smart contract is partitioned into numerous smaller contracts as an example. Some are supposed to be unchangeable, while others have the ability to be deleted. This means that a portion of the code (smart contracts) may be removed and replaced while the rest of the code remains working.

Benefits and applications

Smart contracts, being programmable code, are extremely flexible and may be constructed in a variety of ways to provide a variety of services and solutions.

Smart contracts, as decentralised and self-executing programmes, may give improved transparency and lower operating expenses. They can also improve efficiency and cut bureaucratic costs, depending on how they're implemented.

Smart contracts are especially beneficial in cases where two or more parties must transfer or trade cash.

To put it another way, smart contracts can be tailored to a wide range of scenarios. Tokenized assets, voting systems, crypto wallets, decentralised exchanges, games, and mobile applications are just a few examples. They might also be used in conjunction with other blockchain technologies for healthcare, charity, supply chain, governance, and decentralised finance (DeFi).

ERC-20 Tokens issued on the Ethereum network adhere to the ERC-20 standard. All Ethereum-based tokens' essential operations are described in the standard. As a result, these digital assets are commonly referred to as ERC-20 tokens, and they make up a significant component of the cryptocurrency market.

To issue their digital tokens on the Ethereum network, several blockchain enterprises and startups used smart contracts. Following the issue, the majority of these firms used Initial Coin Offering (ICO) events to distribute their ERC-20 tokens. In most situations, smart contracts made it possible to swap cash and distribute tokens in a trustless and efficient manner.

Limitations

Smart contracts are made up of human-written computer code. As a result, there are several dangers since the code is vulnerable to errors and vulnerabilities. They should, in the ideal world, be designed and deployed by skilled programmers, especially when dealing with sensitive data or big sums of money.

Aside from that, others say that centralised systems can provide most of the smart contract's solutions and features. Smart contracts, on the other hand, execute on a distributed P2P network rather than a centralised server. And, because they're built on the blockchain, they're either immutable or extremely difficult to modify.

Being unchangeable might be beneficial in certain situations but detrimental in others. For example, millions of ether (ETH) were stolen when a Decentralized Autonomous Organization (DAO) dubbed "The DAO" was hacked in 2016 because to weaknesses in its smart contract design.

Developers were unable to fix the code since their smart contract was immutable. This resulted in a hard fork, resulting in the formation of a second Ethereum chain. To put it another way, one chain "reverted" the hack and restored the cash to their rightful owners (this is part of the current Ethereum blockchain). The other chain chose not to intervene in the attack, claiming that events on a blockchain should never be altered (this chain is now called Ethereum Classic).

It's worth noting that the issue was not caused by the Ethereum blockchain. Instead, a defective smart contract implementation was to blame.

Another disadvantage of smart contracts is their ambiguous legal status. Smart contracts are not only illegal in most countries, but they also don't fit into the current legal framework.

Many contracts, for example, demand that both parties be properly recognised and over the age of 18. The lack of middlemen paired with the pseudonymity afforded by blockchain technology may jeopardise such criteria. While there are potential answers, the legal enforceability of smart contracts is a significant difficulty, particularly in borderless, distributed networks.

Criticism

Smart contracts, according to some blockchain proponents, will soon replace and automate a large portion of our commercial and governmental institutions. While this is a feasible scenario, it is unlikely to become the norm.

Smart contracts are undoubtedly a fascinating piece of technology. However, in other cases, their distributed, predictable, transparent, and relatively unchanging nature might make them less desirable.

The main point of contention is that smart contracts aren't a good fit for a lot of real-world situations. In fact, some businesses might be better suited sticking with traditional server-based solutions.

Compared to smart contracts, centralised servers are simpler and less expensive to operate, and they tend to be more efficient in terms of speed and cross-network communication (interoperability).

Last thoughts

Smart contracts have undoubtedly had a significant impact on the world of cryptocurrencies, and they have undoubtedly revolutionised the blockchain space. Smart contracts will likely enable a wide range of applications in the future, ranging from financial services to supply chain management, even if end-users do not engage with them directly.

Smart contracts and blockchain, when used together, have the ability to alter practically every aspect of our civilization. However, only time will tell if these ground-breaking technologies will overcome the numerous challenges to wide-scale implementation.

credit: Binance Academy