Smart contracts are a key ingredient to add to products in the world of blockchain technology & in the world of cryptocurrency as smart contracts allow developers to build decentralized apps which are referred to as dapps & create tokens, taking advantage of blockchain security, reliability & accessibility and creating peer-to-peer functionality such as the creation of peer-to-peer lending.
What Exactly is a Smart Contract?
A simple definition of a smart contract is: a method of settling a transaction after a payment, for instance, has occurred.
With the emergence of Ethereum in 2015 which was a second generation cryptocurrency, Ethereum popularized a feature of second generation cryptocurrency which was smart contracts which came on the scene. The earlier generation blockchain which was Bitcoin does not support complex smart contracts.
Smart contracts are written in a variety of programming languages which can be written by any user of a blockchain network that supports smart contracts & can then be deployed to a blockchain, but once smart contracts are deployed to a blockchain the creator cannot alter the smart contract (there are exceptions to this rule), this helps ensure that smart contracts deployed to a blockchain cannot be censored or shut down & it's imperative to have some knowledge of coding & having familiarity with blockchain technology is key because if done incorrectly there are consequences such as loss of your cryptocurrency by locking up your cryptocurrency irretrievably & another consequence is sending cryptocurrency to the incorrect place. Each smart contract's code is transparent, publicly verifiable, stored on the blockchain & is operative in the end-user experience background of most consumer cryptocurrency products.
Each computer on a network is called a node. A node stores copies of all existing smart contracts & their present state alongside the blockchain data & alongside transaction data.
Examples of Smart Contracts
- Decentralized Exchanges: Uniswap being an example of a smart contract powered application. Decentralized Exchanges are exchanges allowing users to trade cryptocurrency without a centralized authority setting exchange rates.
- Stablecoins: which are digital currencies pegged to a stable reserve asset such as the U.S Dollar or even gold.
The Difference Between Traditional Contracts & Smart Contracts
- Traditional Contracts:
An example of a traditional contract is in the corporate world, regardless of blue collar or white collar, factory or office, when a hiring manager offered the job applicant the position of employment, the new employee was given a printed contract in paper format, which outlined the terms & conditions of employment & the employee would with a pen, sign agreement to the terms and conditions of the offer of employment. The employee agreed to the payment of time the employer wanted & in exchange the employer's weekly, bi-weekly or monthly agreement made to the employee would be to give the employee a paycheck. The employee paid the currency of time to the employer & in exchange for receipt of employee time currency the employer paid the fiat currency value that the employee's time was worth & the agreement was a traditional contract but the intermediary or middleman was the tax man who took his cut from the transaction since the employer has to register a payroll account with the CRA & the paycheck was credited into the employee's bank account via Direct Deposit making the bank the centralized authority & trusted intermediary who validated the transaction.
- Smart Contracts
Like traditional contracts with terms & conditions printed on paper, smart contracts set terms & conditions but with smart contracts the terms and conditions are executed as code running on blockchain. But if executing smart contracts on the Ethereum Network the prerequisite is the payment of a gas fee to keep the network running, hence the name "gas", similar to keeping a 2002 WS6 T-Top Coupe Fourth Generation Pontiac Firebird 5.7 litre LS1 V8 engine running requires payment for gas to avoid running on empty.
A Smart Contract Weak Spot
Smart contracts deployed & running on the blockchain relies only on information that is stored in the records of that blockchain which is related to the circulation of that specific cryptocurrency & related assets limiting smart contracts to only one specific blockchain. To deal with this problem blockchain developers created a concept which is referred to as an Oracle & what an Oracle does is feed external information into a blockchain system.
Benefits of Smart Contracts
Prior to the advent of smart contracts, money transfers, both domestic and international, required trusted intermediaries such as the bank to act as the middleman, but smart contracts not only eliminate the trusted intermediaries, but in addition what smart contracts have done is create secure automation & decentralization in any type of transaction offering not only security but borderless accessibility.
Smart contract powered apps or dapps includes DeFi apps which allows users regardless of geolocation who hold cryptocurrency the opportunity to engage in complex financial transactions such as loans or peer-to-peer lending & insurance without the intervention of an intermediary such as a centralized financial institution taking their share of the transaction. For instance, the platform Compound uses smart contracts allowing investors to earn interest & allows borrowers to secure a loan with no requirement of a bank to act as a trusted intermediary, this is due to the fact that when a smart contract receives funds from a user its code is executed on the blockchain by all nodes in the network in order to reach consensus in relation to outcome & resulting flow of value & this allows smart contracts to take advantage of blockchain security and run securely on the blockchain with no need of trusted intermediaries even during events when users make complex financial transactions with unknown entities because don't forget as mentioned earlier in this article an Oracle can feed external information into the blockchain system.
Blockchain technology & smart contracts coupled together as the power twins so to speak has been the gamechanger in the web 3 arena, not only does DeFi aim to create new DeFi products & services which rival web 2 powered Fintech apps such as Kroo, but smart contracts which came on the scene as a feature of second generation cryptocurrency has now proved to be a valuable tool which has helped in the creation, emergence & popularization of DAOs or Decentralized Autonomous Organizations which rival the model of the Traditional Organization with centralized decision-making & reliance on the legal framework & internal policies. Even though theoretically the concept of DAOs sounds great, practically with DAOs there is risk involved, but, DAOs use smart contracts & DAOs do have great potential but alongside challenges.
In conclusion, smart contracts emerged as a feature of second generation cryptocurrency (specifically Ethereum) in 2015, but this feature of second generation cryptocurrency has helped usher in dapps & the DAO model and a key benefit of smart contracts lies in its ability to facilitate & expand the reach of decentralization.