Understanding Smart Contracts

Introduction

The term 'smart contract' has become increasingly popular in the era of blockchain technology.

It may come as a surprise to many that the concept of a smart contract was first introduced by Nick Szabo, an American computer scientist, back in the 1990s.

Szabo's visionary definition describes a smart contract as 'a computerized transaction protocol that executes the terms of a contract.' This groundbreaking idea laid the foundation for the development of smart contracts as we know them today.

Why are smart contracts important?

Contracts serve as agreements between two or more parties, forming the basis of various transactions and interactions. In traditional contract systems, trust is established through reliance on each party's integrity or the involvement of a trusted intermediary, such as a bank in financial transactions.

One of the remarkable aspects of a smart contract is its ability to facilitate agreements without the need to rely on trust in the other party or even a third-party intermediary for contract execution. This is achieved through the inherent programmability of smart contracts, enabling them to automatically execute agreements once the predetermined terms and conditions are met.

By eliminating the necessity for trust and introducing automated execution, smart contracts provide a level of efficiency, transparency, and reliability that revolutionizes the way agreements are made and fulfilled.

“I call these new contracts “smart” because they are far more functional than their inanimate paper-based ancestors. No use of artificial intelligence is implied. A smart contract is a set of promises, specified in digital form, including protocols within which the parties perform on these promises”.
Nick Szabo.

Let's illustrate the functioning of a smart contract through a straightforward analogy involving a vending machine:

Although it was not possible to create a smart contract in the 90s as we do today, Szabo had already noticed how incredible and revolutionary it could be. You can check his article for more information.

Smart Contracts today

Szabo couldn’t build smart contracts at that time due to the absence of blockchain technology.

Blockchain technology has unlocked the potential to create and execute smart contracts autonomously, eliminating the reliance on third parties and fostering the development of decentralized systems.

By leveraging blockchain's inherent capabilities, smart contracts offer a range of advantages. Firstly, their execution is trustless and self-enforcing, ensuring transparency and efficiency in agreement fulfillment. Furthermore, being built on a blockchain provides a transparent environment where code can be validated, and transactions can be openly tracked.

This transparency enhances security, accountability, and fosters a sense of trust among participants in the ecosystem.

Some of the most popular blockchains where developers build smart contracts and applications are:

• Ethereum, where it’s possible to program them using Solidity and Vyper
• Avalanche, also using Solidity
• Near protocol, which uses Rust as its smart-contract programming language.
• Cardano, which uses Plutus as its smart-contract programming language.

Smart Contracts and Decentralized Finance (DeFi)

Smart contracts form the backbone of Decentralized Finance (DeFi), a revolutionary domain that aims to disrupt traditional financial systems by democratizing access to financial services.

By utilizing smart contracts, DeFi applications automate financial transactions and services like lending, borrowing, and trading without the need for traditional intermediaries such as banks or brokerage firms.

This new financial ecosystem presents promising opportunities and unique benefits, such as financial inclusion, open access, high yield opportunities, and transparency. However, it also comes with its own set of challenges and risks, such as those related to regulatory uncertainties.

Limitations

Despite their numerous benefits, smart contracts do have limitations, as we point out below:

1. Smart contracts are unable to directly access external information from sources such as other blockchains or real-world markets. To address this challenge, developers have devised a solution known as oracles, which act as bridges between the blockchain and external data sources, enabling smart contracts to interact with and utilize off-chain information.
2. Smart contracts have a size limit. On Ethereum, for example, it’s 24KB.
3.  While smart contracts offer immense potential, their development by anyone can introduce the risk of malicious actors exploiting poorly written or flawed code. This issue can be mitigated through the involvement of reputable companies that specialize in code auditing, making sure they are safe to use.

Closing thoughts

Smart contracts and blockchains, such as Ethereum, are definitely here to stay. This disruptive technology holds immense potential to revolutionize numerous sectors, however, for widespread adoption on a global scale, there are certain aspects that require further improvement and refinement.

The landscape of smart contract development is witnessing the emergence of numerous new blockchains and protocols, each striving to elevate the level of competition and innovation. This surge of new players brings forth an exciting future filled with boundless possibilities.

It's important for us to pay attention as these new players shape the future of the industry. By staying informed and involved, we can actively participate and contribute to the ongoing growth of smart contract technology, fostering an environment of constant progress and unlocking its complete potential.