Crypto Basics #2: What are Smart Contracts?

By 2sats | 2sats | 21 Apr 2022

*obligatory not financial advice*



In this series I want to explain some terms that are relevant to the amazing world of cryptocurrencies to help newcomers understand it better. Today I want to talk about Smart Contracts.


Previous Part: Crypto Basics #1: What even is a Blockchain?


What are Smart Contracts?

A smart contract is a code that is running on a blockchain and is generally not changeable after it launches. Such contracts can hold cryptocurrencies themselves and distribute them automatically based on for what they were coded for. This makes them the foundation for things like Decentralized Finance and allows people the exchange and use of their crypto in a trustless manner without a third party.

For example, you could want to sell a digital asset, like any token or an NFT, and I could want to buy it. But it would be foolish of you to just send your asset to me directly and just hope that I will pay the amount we agreed on. Instead we could set up a smart contract, where you can send your asset to and only if I also send the payment to the smart contract it will automatically send us both what we wanted. No chance of either side screwing the other over by not fulfilling their part. Btw that’s pretty much how NFT marketplaces work.

Such contracts can also be much more advanced. Lending protocols, like Aave, allow their users to deposit funds to earn a yield or to borrow them in exchange for interest if they meet certain criteria, they can also automatically sell a borrower’s collateral if its value falls to a certain point. Decentralized exchanges, like Uniswap, allow their users to deposit funds into trading pairs and let traders swap them for prices that are set automatically for a trading fee.

The advantage over traditional finance is that a smart contract absolutely can only do exactly what it was coded for and is completely indiscriminately and unbiased. Cryptocurrencies and blockchains were invented with the intention of decentralizing important sectors like finance, and smart contracts are integral to that by allowing their users to exchange or lend them without a middle man.

It can happen that a smart contract does something unintended or is a failure, but that could only happen if there is a flaw in its code. Which is why their users do need to be a little bit careful and make sure that the code has been battle tested and audited.

The first blockchain that allowed the creation of such contracts is Ethereum, which is now the second largest cryptocurrency by market cap. Ethereum is currently experiencing many problems because it can't handle all the transactions and is notorious for its high fees and slow speed but there are some attempts to make the blockchain more scalable and there are also countless other chains that are focusing on smart contracts, each with their own ups and downs like Tezos, Tron, Flow, Algorand, Solana, Binance Smart Chain, Celo, Juno and many more.


I hope that short explanation was helpful for some new comers. I will keep writing more such short articles about various crypto terms. Feel free to follow me if you are interested.




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