Blockchains are changing the way data is registered, processed, transferred and used. They are a synonym of transparency, democracy and access. As we keep discovering new applications for this disruptive technology, we further develop it to unlock new possibilities. That is where smart contracts come in.
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Smart contracts are the laws that rule the blockchain
A traditional contract is a specific agreement that defines a set of rules between two or more parties. Similarly, a smart contract is pretty much the same, except that it is written in code and programmed onto the blockchain. Thus, just like any other set of data, the network safely stores them in each node. Nobody can alter or delete them.
However, what makes smart contracts smart is that they execute themselves. As they run on the blockchain, they are automatically enforced without a third party to oversee it.
Furthermore, they eliminate another common problem amongst traditional contracts: misinterpretation. Code is unaffected by opinion or points of view; it is objective. It has no meaning, only functionality. All that matters is that it works.
To sum up, smart contracts are a series of rules and commands written in code and running on the blockchain. They establish the conditions under which users interact with each other. They are inalterable, undeletable and accessible for everyone.
How do smart contracts work?
As we said, smart contracts establish the rules that users agree upon when they interact. They also set the conditions necessary for it to execute. Then, and only then, the transaction will go through and appear on the blockchain.
Let’s suppose you want to buy a car from an innovative dealership that takes crypto as payment. They have a platform programmed and running on Ethereum. In the simplest of terms, their smart contracts set the following rules:
- The car costs 15 ETH.
- When the dealership wallet address receives 15 ETH, the platform will generate 1 (one) token as proof that a purchase has happened.
- The wallet that made the payment of 15 ETH will then receive that token.
Now, all you’d have to do is go to the dealership and hand them your token as proof of payment in exchange for a brand new car. All done!
Of course, this is an oversimplified example to show how smart contracts work, but you get the point: No commissions, no banks, no brokers, no third parties whatsoever. Transactions only go through when they meet the conditions established on the smart contract and agreed upon, so everyone is satisfied. Information is secure and registered in an indestructible ledger. All executed through a line of code.
Opportunities and advantages
Aside from the payment transactions processing, smart contracts have proven to have an infinite number of use cases. Governance, economy, health, marketing, you name it! Their utility ranges from the most simple applications to more complex solutions. Potential is limitless as every organization, institution, and business uses data for its everyday operations.
Not only that, but smart contracts and cryptocurrency nurture one another, as the development of one encourages the adoption of the other. New use cases for smart contracts opens new possibilities for cryptocurrency. Viceversa, cryptocurrency adoption drives demand for smart contract development. It is an almost perfect cycle.
Yet utility is only one of the value propositions this technology has to offer. There is also practicality. As of Q1 2021, for example, you can’t do business from Argentina with someone in Singapore without paying a ridiculous amount of taxes, going through customs, and submitting to the will and methods of financial institutions. Not in the traditional way, at least. Thanks to smart contracts, you can not only do that easily but also without the intervention of a third party. Not to mention completely tax-free. Your only expenditure would be the miners’ fee. Simple, instant, independent and cost-effective.
Smart contracts are such a valuable technology that Binance developed a whole new blockchain, Binance Smart Chain, to run parallelly to their original blockchain and provide smart contract support.
In fact, the whole DeFi ecosystem is possible thanks to smart contracts. Every DEX, loan platform, liquidity pool, staking pool and so on functions on smart contracts that determine the parameters under which they work. They also enable creating new assets on a blockchain, like wrapped tokens, stablecoins, NFTs, or LP tokens.
Risks and downsides
Though opening a horizon of new possibilities for development, smart contracts can have some setbacks.
First of all, programming languages are a specific field in which most people have little knowledge. If you don’t know how to code, you will be operating and putting your money in a system you don’t understand, which is always a dilemma. As we said, smart contracts are the laws that rule the blockchain. Not understanding these rules could lead to severe problems for anyone who doesn’t take precautions.
That leads us to another potential risk: programming errors. Although code is indisputable, it is still humans who write it, and they can indeed make mistakes. Flawed code can suffer from exploits. Alike taking advantage of legal vacuums and fine print in traditional contracts, hackers could do the same in faulty smart contracts.
Many platforms, like Yearn.Finance, have undergone attacks due to an error on their code, causing many cryptocurrency users to lose their money. Lucky for everyone, you can protect yourself from this kind of risks by using open-source platforms, which publicly share their code for everyone to review it and look for weaknesses. Private audits are also common practice, but it’s up to you to trust both the auditor and the audited in those cases.
If information travelled in cars and blockchains were the streets they transited, smart contracts would be the set of signs, traffic lights, and rules to follow to arrive at the destination.
We are barely discovering the world of blockchain and smart contracts. Some institutions are already developing groundbreaking solutions in diverse aspects. Thanks to this technology, we can only expect a brighter future for the way we do personal finance, data management, or simply interact with each other through the internet.