What Is a Smart Contract in Crypto?

Written by

Tamara T.

Senior Writer

Published Jul 27, 2023 at 9:45 AM
Last updated Feb 21, 2024 at 3:54 PM

Enter the exciting realm of smart contracts! Smart contracts are self-executing programs that aim to execute all the conditions in a contract or an agreement automatically when a predetermined criteria is met. Upon completion, all transactions are immutable and trackable.

Smart contracts are attractive because they eliminate the necessity of trusting third parties in online transactions. They offer a trustworthy infrastructure for developing dApps that leverage blockchain technology for secure peer-to-peer interactions.

In this article, you'll learn what smart contracts are, how they function, and where you might use them. You will explore how to create self-enforcing agreements and their potential uses and drawbacks.

Key Takeaways 

  • Smart contracts are self-executing programs that automate contract actions and enable reliable transactions without intermediaries.
  • They offer transparency, security, efficiency, and cost savings in various industries.
  • Smart contracts follow predefined conditions ("if/when...then...") to execute actions on the blockchain.
  • Ethereum is a popular platform for smart contracts, but other blockchains also support their development and execution.

 

History Of Smart Contracts

The first idea for smart contracts appeared in 1994, when cryptographer Nick Szabo first presented this concept. He introduced a digital currency named ‘Bit Gold’, a currency that was never launched and precedes Bitcoin (BTC). He also gave the first definition of a smart contract, explaining it as  “a computerized transaction protocol that executes the terms of a contract,” with objectives to “satisfy common contractual conditions, minimize exceptions both malicious and accidental, and minimize the need for trusted intermediaries.”

Smart contracts started to get more attention only with the emergence of blockchain technology in 2009. Blockchain provided the opportunity to build decentralized, reliable networks that don’t rely on a centralized authority for the execution of smart contracts. Ethereum was the first platform to support smart contracts. After Vitalik Buterin presented his white paper in 2013, Ethereum was launched as an innovative sort of blockchain for smart contracts. 

However, it didn't rely on the standard rules, but a “world computer” able to execute a lot of independent smart contracts at the identical time. Since the first idea and official creation, smart contracts have made staggering progress and now have even wider applications in different industries, such as real estate, gaming, insurance, voting systems, and many others.
 
 

How Do Smart Contracts Work?

Smart contracts function similarly to digital agreements, with predetermined conditions automatically triggering specified actions. To ensure safe and reliable transactions, smart contracts use "if/then" logic, in which certain conditions are met, and the related actions are carried out automatically.

Let's break it down into layman's terms with a simple example.

How Smart Contracts Work

Put yourself in a situation where you want to buy a house from someone, but you don't trust each other completely. In order to conduct a transaction with complete trust and openness, you've decided to employ a smart contract.

  • Create the smart contract: This step requires mutual consent on essential terms like price, payment terms, and ownership transfer criteria. A piece of computer program known as a "smart contract" contains these agreements.
  • Criteria and execution: The smart contract is pre-set to require certain criteria to be met before proceeding with the transaction. It may stipulate, for instance, that you have to send a specific quantity of cryptocurrency to a given address and that the seller has to produce particular paperwork and evidence.
  • Triggering the smart contract: Smart contracts are automatically activated after all prerequisites are met and both parties have agreed to the terms. Because of this, neither you nor the seller will need to go through any third parties, like banks or lawyers, to exchange money or legal documents.
  • Immutable and transparent: The blockchain, a distributed and secure digital ledger, records the transaction data in a way that is both immutable and transparent. This makes the transaction immutable, meaning that it cannot be altered in any way. The transaction details are accessible to both parties, fostering open communication and confidence.

The smart contract in the above house-buying example removes the need for a third party, lessens the possibility of fraud, and guarantees that all commitments are met before the sale is finalized. 

However, it is worth noting that there are many more potential applications for smart contracts outside of real estate transactions, including insurance claims, supply chain management, and crowdfunding. They provide secure and transparent transactions and agreements through the use of automated processes that cut out the middleman.
 
 

How Are Smart Contracts Used On Different Platforms?

Smart contracts are important because they enable developers to generate a variety of decentralized apps. They have applications in different fields, including finance, healthcare, logistics, insurance, gaming, and more. The elimination of middlemen in decentralized and secure transactions is a major benefit of smart contracts.

Applications powered by smart contracts are also known as “decentralized applications”, or “dApps”. Such apps allow users to take part in complicated financial transactions without the inclusion of a bank or any central institution.

Some common applications of smart contracts across various environments are as follows:

  • Ethereum: dApps are powered by smart contracts on Ethereum, and some examples of these are Uniswap, which is a decentralized exchange; Compound, which is a lending platform; and ERC-20 tokens, which are token issuance platforms.
  • BNB Smart Chain: Decentralized exchanges like PancakeSwap and yield farming platforms like Venus are just two examples of the types of DeFi applications that can take advantage of the smart contracts offered by BNB Smart Chain.
  • Cardano: Financial transactions, supply chain management, and electoral systems will all benefit from the security and transparency made possible by Cardano's smart contracts.
  • Polkadot: Polkadot's smart contracts facilitate cross-blockchain communication and data sharing, enabling the creation of sophisticated distributed applications.
  • Tezos: Tezos smart contracts make it possible to build blockchain systems that can automatically make protocol upgrades through consensus. As a result, there will be greater leeway and adaptability in the long run.

These use cases highlight the versatility of smart contracts, which may be applied to a wide range of problems in areas such as finance, governance, supply chain management, and more. Smart contracts upend established procedures by removing middlemen and ensuring trust via computer code, paving the way for decentralized innovation.
 
 

How To Create Crypto Smart Contracts

There are a few steps involved in the creation of crypto smart contracts. Here is a simplified explanation of the process:
 

Define The Terms

The terms and conditions of the contract that will be encoded into the smart contract are agreed upon by all parties involved in the transaction. This involves laying out the rules, regulations, and conditions that will be enforced as a result of the contract.
 

Write The Code

When it comes time to write the code for the smart contract, developers will use programming languages like Solidity (which is used by Ethereum). The instructions and logic that will govern how the contract will operate and how the terms that were agreed upon will be enforced are contained in the code.
 

Test The Contract

Perform the necessary tests on the contract. Before putting the smart contract into operation on the blockchain, it is essential to perform all of the necessary tests on the contract to ensure that it operates as intended. This helps discover any defects or problems that need to be fixed before the product may be used in the real world.
 

Deploy The Contract

Contract deployment occurs after the testing and validation of the contract, at which point it is sent out onto the blockchain network for use. To accomplish this, the code of the contract must be published and made available to the general public.
 

Execute And Verify

As soon as the smart contract has been deployed, it becomes active and is able to receive inputs or trigger events based on the conditions that have been set. When all of these requirements are satisfied, the contract will automatically carry out its terms, and the result will be stored on the blockchain.
 

Record The Specifics

On the blockchain, each and every interaction and transaction that is associated with the smart contract, as well as the results of those interactions and transactions, are documented as immutable and transparent records. The execution of the contract will maintain its honesty and openness as a result of this.

It is important to note that in order to create smart contracts, one needs specialized technical knowledge in the areas of programming and blockchain platforms. Seeking assistance from experienced developers may be an ideal option.
 

Benefits Of Smart Contracts

Getting an answer to the question “what is a smart contract” is definitely not the end of your research. You have to drill down to discover the real-world benefits of smart contracts, and how they enhance the level of trust among parties.

  • Speed, accuracy, and efficiency: Upon meeting the conditions of the contract, it's time for the automated execution. This means that no party can cancel the execution of smart contracts, as everything happens in a digital form.
  • Transparency: Smart contracts don't involve third parties, and records use encryption for additional security. This increases the level of transparency, since all information is available to participants. 
  • Stellar security: Blockchain records use encryption technology. As a result, breaking the system is almost impossible. Records are mutually connected and distributed in a logical flow. This means that hackers would need to change the whole chain to alter an individual record. 
  • Savings: Smart contracts eliminate the need for the inclusion of third parties in the processes, which reduces the total costs

 Pros and Cons Smart Contracts

Drawbacks Of Smart Contracts

Apart from evident benefits, smart contracts also have some limitations:

  • Security: Despite its high security, smart contracts technology is still in its infancy, and hackers can find loopholes and identify attacking opportunities. This could comprise the whole network.
  • Lack of privacy: Smart contracts are public since they run on an open-source blockchain. The parties may stay anonymous, but the blockchain's transparency can threaten privacy in confidential use cases.
  • Clarity: The terms of the contracts could be unclear, which complicates the execution.  
  • Immutability and inflexibility: When a smart contract is activated on a blockchain, it transforms into an immutable state, which means that it cannot be altered or updated in any simple way. Should it become necessary to bring the terms and circumstances of the contract up to date, the process of doing so might be difficult and time-consuming.
  • Limited scalability: Blockchain smart contracts need computing resources. In high-transaction networks, this might cause scalability issues, which may raise transaction costs and delays.

 

Use Cases Of Smart Contracts 

“What does a smart contract look like?” This is a logical question for people who have never used smart contracts and don't know a lot about their functions and operation principles. Here are a few examples of smart contract use cases in real-world:

  • Smart contracts in insurance: Smart contracts would allow the automatic determination of payment amounts based on the type of policy. This would lower the industry costs that use millions every year to process different claims.
  • Smart contracts in real estate: Smart contracts could be a great method for property registration. This would simplify the process, with the possibility of using them for multiple assets beyond land, buildings, or flats. 
  • Smart contracts in the supply chain: Smart contracts in the supply chain automate inventory management, product authentication, and payment processing, ensuring transparency, efficiency, and avoiding manual errors and delays.
  • Smart contracts in healthcare: Apart from recording health data, smart contracts can improve the traceability of medicines, cold chain management, and clinical research, among other things.
  • Smart contracts in financial services: Smart contracts could improve various financial processes, such as insurance claims, micro-insurance, and micro-lending, while also contributing to transparent auditing. 
  • Smart contracts in gaming: The gaming industry is constantly increasing in size, and many people are showing interest in a fairer system based on transparency. Smart contracts could provide gamers with an enhanced experience, based on trust. 
  • Smart contracts in media: Smart contracts in media reduce intermediaries and provide fair pay for authors by automating content licensing, royalties, and distribution.
  • Smart contracts in DeFi: Decentralized finance (DeFi) is one of the best replacements for traditional payment services. Smart contracts clarify processes and facilitate the management of financial services through dApps.
  • Smart contracts in government procedures: Smart contracts ensure a secure ecosystem for voting, with lower chances for manipulation. Votes would utilize ledger protection that is hard to decrypt.
  • Smart contracts in mortgages: Getting mortgages via smart contracts would be cheaper, more efficient, and safer. This would also lead to earlier access to properties, alongside the automatic update of records.  

 

The Future Of Smart Contracts

As smart contracts continue to transform numerous industries, their future seems bright. Smart contracts will change how commercial transactions are carried out since they can automate processes, guarantee transparency, and do away with the need for middlemen. They have the capacity to improve efficiency, save costs, and streamline processes. 

We can anticipate the integration of smart contract technology into all aspects of daily life, from financial services and supply chain management to healthcare and government processes, as it develops and becomes more extensively used. Smart contracts have the potential to completely change industries and open up new doors for innovation because of their decentralized nature.
 
 

FAQs:

What are smart contracts?

Digital contracts that automatically carry out predetermined activities when certain criteria are satisfied are known as smart contracts.
 

What distinguishes smart contracts from conventional contracts?

With no need for middlemen and automatic, transparent execution without relying on interparty trust, smart contracts are created on blockchain platforms.
  

Are smart contracts safe?

Because smart contracts are created using safe blockchain technology, they are impervious to fraud and tampering. However, security hazards might still come from flaws in the code or outside influences.
  

What industries can benefit from smart contracts?

Numerous industries, including finance, supply chain management, healthcare, real estate, gaming, and others, use smart contracts to streamline operations, cut costs, and increase transparency.