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What are Smart Contracts?

Updated: Feb 21, 2022

What distinguishes smart contracts from traditional contracts?

What distinguishes smart contracts from traditional contracts...

Just to clear up confusion, a traditional contract is very different to a smart contract. Smart contracts are agreements between a buyer and a seller that come into effect in a self-executing, automatic manner when relevant circumstances are met. They are expressed as a piece of code that is designed to carry out a set of instructions. As a matter of fact, the integrated mechanism, or code, gets triggered in an “IF-THEN” (if this condition is met, then do this) approach.

The terms of the agreement are directly written in the lines of the code. The agreement (contract) is enacted on a blockchain network, there are many different blockchains that are currently capable of running smart contracts, Ethereum is the premier blockchain for smart contract usage, but there are many others such as; Solana, Polkadot, and Stellar. The codes determine when the execution takes place, and the transactions following are recorded on-chain as a permanent public record that is irreversible and immutable. Transactions are fully trackable and provide unequivocal proof of contract completion. The information is verified and held by a decentralised blockchain.

For a smart contract to come into effect and the transaction to take place, there is no need for a central authority or middleman, such as a solicitor, to administer the contract. There is also no need for the information to be held or verified by a person or central institution. Due to its decentralised nature, the involved parties find themselves in a secure proposition, as they both have easily trackable records of transactions that can also be provided as irrefutable proof of contract completion. This allows for any disputes to be readily resolved as the correct information is freely available and easily accessible by any member of the public. Proof of ownership for example, is easily clarified as the contract can be easily retrieved and checked.

What are Dapps?

Decentralised apps, or so-called dapps, are basically a series of smart contracts linked together. They provide functions such as automated coin and token exchange, token farms that provide returns for staking of tokens, vaults that automatically collect and reinvest returns from farms. Decentralised Finance (DeFi) is a very common usage for smart contracts as it allows automation of a whole raft of traditional financial activities. Smart contracts can power loan agreements, interest payments, term deposits, and distribution of dividends, all automatically, without the need for third-party intervention.

Examples for Dapps…

• Augur - a tool to speculate on derivatives

• MakerDAO - platform to lend and borrow cryptocurrency without the need of a middleman, eg. bank or finance company

• Uniswap - a platform to swap ERC20 tokens on the Ethereum network

• CryptoKitties - NFT-based crypto-collectibles that can be bred using smart contracts

• Argent - Eutheurum wallet that uses smart contracts to abstract away concepts like addresses and private keys

Let's break it down with an example, such as a car purchase, WITHOUT a smart contract being involved.

You have found a site online that lists all the cars you would like to consider buying. It provides a way of communicating with a particular seller. It also lets you execute the transactions once you decide on a car to purchase and a payment system to exchange ownership. After the purchase has taken place, if warranty was negotiated, the possibility for a refund in case the car turns out to be faulty exists. The site may have a register to exchange ownership with the authorities.

Every single step requires you to trust the site or the particular service which may be controlled by a different organisation or individual. For the whole process to become void, it only takes one simple mistake from any one of the people involved.

Now we can look at this scenario WITH a smart contract being involved.

Anyone can enter into the agreement without having to be verified as the buyer or seller. The agreement is between the buyer and seller only - there is no other people or entities involved. So, no car yard, bank, salesperson or insurance agent. With one click the buyer enters the contract at a set price, the contract is enacted and verified, the outcome is permanently recorded on the blockchain. The buyer now has full ownership of the asset, and the money has automatically been transferred to the seller. The buyer and seller do not need to meet, they can in essence complete the agreement from any physical location. The smart contract acts as the “trust bridge”, this has traditionally been the role of third party intermediates such as banks, money transfer services, and agents. The record will be kept for anyone to search as it is always accessible on the blockchain.

A little historical background…

The first smart contract was proposed in 1994 by Nick Szabo, an American computer scientist. In 1998 he invented a digital currency called "Bit Gold". That took place even 10 years before the invention of bitcoin. Effectively, Szabo is sometimes rumoured to be the real Satoshi Nakamoto, the anonymous inventor of bitcoin, which he has denied.

What can be improved…

Although smart contracts can be seen as a trustless way of enforcing agreements, they also are immutable. Even though that can be seen as an advantage in most circumstances, it can have fatal implications when the underlying code is erroneous. There is no way of the code being altered or updated in that case, a new smart contract code must be written to solve this problem. Code must be audited by experts to check that there is no malicious or incorrect code and that the smart contract functions as intended. This also offers assurance to those utilising the smart contract.

What has been done so far and where can we head with smart contracts…

Moving forward, smart contracts are going to change how we do business on multiple levels. They essentially take out the middle man in a transaction, thus making many transactions much cheaper than traditionally possible. Smart contracts and blockchain networks are going to replace a variety of occupations and possibly even entire industries in the future. The sector has a promising future and it is worth considering blockchain and smart contracts as a career option as the future demands are extensive.

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