Key takeaways 

• Smart contracts are digital contracts on a blockchain that automatically execute when conditions are met.
• They operate on “if/when...then...” logic and are recorded on the blockchain for transparency and security.
• Smart contracts are used in decentralized finance (DeFi), supply chain, real estate, healthcare, insurance and gaming.
• Benefits of smart contracts include speed, efficiency, accuracy, trust, transparency, security and cost reduction.
• Challenges faced by smart contracts include immutability, the need for accurate coding, security loopholes and reliance on programmer expertise.

Smart contracts are digital contracts stored on a blockchain. They automatically execute when certain conditions are met. Think of them as self-running programs that handle agreements and transactions without needing an intermediary. Once the contract’s terms are satisfied, it enforces itself.

In the Web3 space, smart contracts are like pollen: they are all around us, whether you notice them or not, and are vital to the growth and operation of the new internet.

Every time you make a peer-to-peer trade on a cryptocurrency exchange, a smart contract facilitates the transaction without intermediaries. 

Whenever you purchase a piece of digital art on a non-fungible token (NFT) marketplace like OpenSea, a smart contract verifies the transaction and transfers ownership. 

Any time you participate in a decentralized finance protocol to lend or borrow, a smart contract automatically enforces the loan terms.

Indeed, you can wander through Web3 without ever needing to understand how these snippets of code work, but naturally, you’re curious — otherwise, you wouldn’t be here.

Smart contracts explained

Smart contracts are self-executing contracts stored on a blockchain. They automatically carry out their terms when predefined conditions are met, eliminating the need for intermediaries. Think of them as digital agreements that enforce themselves, ensuring that transactions are completed as agreed upon.

This automation can cut costs, speed up processes and reduce human error.

For example, imagine you’re buying a car online. A smart contract could be set up to transfer ownership and release payment only when both the buyer and seller have met their agreed-upon conditions. 

Once the seller uploads proof of delivery, the smart contract verifies this and then releases the funds to the seller while updating the car’s ownership records to the buyer. This ensures a smooth, trustworthy transaction without needing an intermediary.

How smart contracts work 

Smart contracts operate on simple “if/when...then...” statements. Here’s how it works: if a specific condition is met, the contract executes the agreed-upon action.

Imagine a vending machine. You insert a coin (condition met), and then the machine releases a snack (action executed). Smart contracts work similarly but in the digital realm. For example, if you send a certain amount of cryptocurrency to a smart contract, then it will automatically transfer a digital asset, like a token, to your account.

Blockchain plays a crucial role here as a decentralized ledger that records all transactions transparently and securely. When a smart contract is created, it’s stored on the blockchain. 

When conditions are met, the blockchain verifies and records the transaction, ensuring it is tamper-proof and transparent. This way, everyone involved can trust that the contract will execute exactly as programmed, without needing an intermediary or centralized authority.

Did you know? Executing a smart contract on platforms like Ethereum requires a fee called “gas.” This fee compensates miners for the computational power needed to process and validate transactions.

History of smart contracts

The concept of smart contracts has a fascinating history dating back several decades and has evolved significantly with advancements in blockchain technology.

• Nick Szabo’s concept: In 1994, Nick Szabo, a computer scientist and legal scholar, introduced the idea of smart contracts. He envisioned using software to enforce contractual agreements automatically, eliminating the need for intermediaries. Szabo’s concept was groundbreaking, proposing that digital code could manage and execute contract terms much like a vending machine dispenses goods when the correct currency is inserted.
• Bitcoin’s emergence: The introduction of Bitcoin (BTC) in 2008 by an anonymous person or group known as Satoshi Nakamoto laid the groundwork for blockchain technology. Bitcoin’s underlying blockchain demonstrated how a decentralized, tamper-proof ledger could support digital transactions, setting the stage for more advanced applications like smart contracts.
• Ethereum’s proposal: In 2013, Vitalik Buterin, a young programmer, proposed Ethereum, a new blockchain platform designed specifically to support smart contracts. Buterin’s vision was to create a decentralized platform where developers could build and execute complex applications beyond simple financial transactions.
• Ethereum’s launch: Ethereum officially launched in 2015, introducing its own cryptocurrency, Ether (ETH), and a platform capable of executing smart contracts. This marked a significant milestone, as Ethereum’s blockchain could run code for smart contracts, enabling decentralized applications (DApps). This innovation opened up possibilities for various sectors, including finance, real estate and supply chain management.
• ICO boom: The initial coin offering (ICO) boom in 2017 showcased the potential of smart contracts. Startups used Ethereum’s platform to create and sell tokens, raising capital by issuing digital assets. Smart contracts facilitated these transactions, ensuring funds were only released when specific conditions were met.
• DeFi and NFTs: From 2020 onward, smart contracts have been at the heart of the DeFi movement and the rise of NFTs. DeFi applications use smart contracts to create decentralized financial instruments like lending platforms and decentralized exchanges. NFTs, unique digital assets representing ownership of art, collectibles and more, are also powered by smart contracts, ensuring provenance and authenticity.

Today, smart contracts continue to evolve, with ongoing research and development aimed at improving their efficiency, security and scalability. They remain a cornerstone of blockchain technology, driving innovation across various industries and transforming how we handle digital agreements.

Applications of smart contracts

Smart contracts are reinventing many industries worldwide by automating processes, enhancing transparency and reducing the need for intermediaries. 

Here are some key applications:

Firstly, there’s DeFi. This is one of the most significant applications of smart contracts. DeFi platforms use smart contracts to create financial instruments like lending, borrowing and trading without traditional banks.

• For example, Uniswap is a decentralized exchange (DEX) that allows users to trade cryptocurrencies directly from their wallets using smart contracts. 

Then, there are smart contract supply chain implications to discuss. After all, smart contracts improve supply chain transparency and efficiency. They can track goods from production to delivery, ensuring that all parties have accurate, real-time information.

• For example, IBM’s Food Trust uses smart contracts to trace the journey of food products. This system enhances food safety by quickly identifying contamination sources and ensuring compliance with regulations.

Next, there are smart contracts in real estate. Smart contracts can simplify and secure transactions in real estate, from property sales to rental agreements. They ensure that all conditions, such as payment and transfer of ownership, are met before completing the deal.

• As an example, Propy is a real estate platform that uses smart contracts to facilitate property transactions. Buyers and sellers can complete deals online, with all necessary documents and payments handled automatically by the smart contract.

Smart contracts can also streamline healthcare processes, such as patient consent, data sharing and insurance claims. They ensure that sensitive information is only accessible to authorized parties and that claims are processed efficiently.

• MedRec, for example, is a project that uses smart contracts to manage patient records. It allows patients to control who can access their data, enhancing privacy and security.

Insurance companies use smart contracts to automate claims processing, reducing the time and cost involved. They can automatically verify claims and disburse payments based on predefined criteria.

• For example, Etherisc is a decentralized insurance platform that uses smart contracts to offer flight delay insurance. If a flight is delayed, the smart contract automatically pays out the insured amount to the traveler.

Finally, how could we not talk about gaming? Smart contracts can manage in-game assets and ensure fair play. They enable true ownership of digital assets, which players can trade or sell outside the game.

• Axie Infinity is the most well-known example of using smart contracts to manage its in-game assets and economy. Players can own, trade and breed digital pets called Axies, with transactions secured and enforced by smart contracts.

Did you know? Smart contracts are the backbone of decentralized autonomous organizations (DAOs), which are organizations run entirely by code instead of people. Decisions are made based on pre-programmed rules and member votes, with all actions executed by smart contracts.

Benefits of smart contracts

The unique benefits that smart contracts can offer the aforementioned industries are key to their success. Let’s take a look at a few: 

• Speed and efficiency: Smart contracts automatically execute once conditions are met, eliminating the need for manual processing. This speeds up transactions and reduces delays.
• Accuracy: Because smart contracts are digital and automated, they minimize errors that can occur with manual handling. The exact terms and conditions are executed as programmed, ensuring precision.
• Trust and transparency: Smart contracts are stored on a blockchain, which is transparent and immutable. All parties can see the contract and trust that it will execute exactly as agreed without any hidden clauses or alterations.
• Security: Blockchain technology secures smart contracts, making them resistant to tampering and fraud. Once a contract is recorded, it can’t be changed, providing a secure environment for transactions.
• Cost reduction: By eliminating intermediaries like brokers, lawyers and banks, smart contracts reduce the costs associated with traditional contracts. This streamlining also cuts down on the time needed to complete transactions.

Challenges and limitations

While smart contracts offer numerous benefits, they also come with some challenges and limitations, no doubt hindering an overnight mass adoption event:

• Immutability: Smart contracts can’t be easily changed once deployed on the blockchain. This immutability ensures security but also means that any mistakes in the contract code are permanent and can be costly to fix.
• Need for accurate coding: Smart contracts rely heavily on precise coding. If there’s a bug or error in the code, it can lead to unintended outcomes. The contract will execute exactly as written, which can be problematic if the code isn’t perfect.
• Security loopholes: While blockchain technology is generally secure, smart contracts themselves can have vulnerabilities. Hackers can exploit these loopholes, potentially leading to significant financial losses. Regular audits and thorough testing are essential to minimize these risks.
• Reliance on programmer expertise: The execution of smart contracts depends on the skill and knowledge of the developers who write them. Poorly written contracts can fail to perform as intended, highlighting the need for experienced and trustworthy programmers.

Smart contracts, while powerful, require careful consideration of these challenges. As such, their adoption curve is likely to be slow and steady. 

Did you know? The DAO, a decentralized venture fund on the Ethereum blockchain, raised over $150 million but was hacked due to a vulnerability in its code, leading to a loss of about $50 million. This incident resulted in a major crisis and a controversial hard fork in the Ethereum community, creating two separate blockchains: Ethereum and Ethereum Classic.

The future of smart contracts

The future of smart contracts looks promising.

As technology advances, we can expect more sophisticated and user-friendly tools for creating and managing smart contracts. Enhanced security measures and coding standards will likely emerge, reducing vulnerabilities and making smart contracts even more reliable.

As we’ve seen, smart contracts are already making waves in finance, supply chain, real estate, healthcare, insurance and gaming. As their benefits become more widely recognized, adoption is expected to spread to even more industries. For example, governments might use smart contracts for transparent voting systems, and businesses could automate complex compliance processes.

The versatility of smart contracts means they can be adapted for a wide range of uses. We might see them integrated into Internet of Things devices for automated maintenance and repairs or used in intellectual property rights to manage royalties and licensing. The possibilities are vast and continually expanding.

Written by Bradley Peak