Smart Contracts: What Makes Blockchain-Based Agreements So Special?

What are Smart Contracts? Will they change our every day life?

Man in a costume sits on the edge of a road looking at digital contract.

While transferring cryptocurrency using a decentralized network like Bitcoin is a practical use case, smart contracts are the true revolution behind blockchain technology. Used properly, smart contracts can potentially reinvent how we live our everyday lives. 

Smart Contracts are the difference between having full custody of your digital assets and being a fully-fledged personal hedge fund manager. The use of smart contracts within crypto dApps has already disrupted traditional banking, but the future of what can be accomplished with this technology is still being discovered.

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What exactly are smart contracts on the blockchain? Are these complex computer programs truly going to replace intermediaries and reimagine modern businesses, or are they just another buzzword that will be forgotten in a few years?

Explained: Blockchain smart contracts. Let’s dive in.

What are Smart Contracts on the Blockchain?

A smart contract is a piece of code that automatically triggers and self-executes when specific conditions are met. Think of it like a regular contract or agreement that automates the process of validating, executing, and enforcing terms between parties.

Suited individual presents contract.

In practice, a smart contract contains a predetermined set of rules and conditions programmed to execute automatically once the conditions are met. To give a typical example, smart contracts can be designed to imitate escrow solutions. They release payment to a seller after a buyer confirms they’re satisfied with the goods they’ve received. 

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Most smart contracts on public blockchains are permissionless and trustless. This means no central entity governs who has access to them or why. They are censorship-resistant and eliminate the risk of human bias. This is why blockchain advocates worldwide expect smart contracts to ‘bank the unbanked’ and usher in a new future of finance. 

Still confused? No problem!

How Do Blockchain-Based Smart Contracts Work?

An easier way to understand smart contracts is to imagine a vending machine. A vending machine is an automated system that lets buyers exchange money for snacks and drinks. If I buy anything from a vending machine, both the machine and myself enter into an agreement, or a contract, if you will.

Diagram of vending machine smart contract.

Our agreement states that if I give the machine money, the machine will provide snacks and drinks in return. My snack and drink choices and the price I pay to receive them are considered the conditions of our agreement.

After I’ve paid the vending machine and provided my side of the agreement, the machine begins an automated process to fulfill its side of our predefined agreement.

In this example, a vending machine functions like smart contracts within blockchain platforms. Through automation, smart contract code removes our reliance on a trusted intermediary and dramatically streamlines certain processes.

Smart Contract Use Cases

For most, smart contracts in blockchain and distributed ledger technologies are mainly used in crypto-native services. Programmers are using smart contracts to build revolutionary apps and tools in decentralized finance; however, the future holds even more potential.

Industries that rely heavily on intermediaries and trusted providers, like real estate and supply chains, stand to be disrupted by smart contract applications. 

Cryptocurrency, DeFi, and NFTs

If you’ve ever had any exposure to decentralized finance, you’ve probably used smart contracts without even realizing it. Every time you trade tokens on a decentralized exchange or lend digital currencies like AAVE, you use smart contract execution. Even stablecoins, like Cardano’s native DJED token, rely on smart contracts to maintain their USD peg.

If smart contracts weren’t automatically handling these services, taking out collateralized loans or maintaining a stablecoin peg would be cumbersome and expensive. You can collateralize your crypto using lending markets and take out a loan in minutes. 

If you wanted to do the same using traditional services like a bank, it could take months to approve your loan, and you might be overwhelmed with fees.

Minting and trading NFTs also take advantage of smart contract technology. When you mint an NFT, you’re ‘signing’ an agreement, and the automated contract mints your NFT for you. The same goes for trading NFTs. When you buy a non-fungible token on OpenSea, a smart contract accepts your payment and transfers the collectible to your wallet.

Almost the entire on-chain Web 3 ecosystem runs on smart contracts.  

Real World Use Cases 

Buying a home or investing in property is meant to be an exciting and fulfilling process. However, the immense paperwork and grotesque legal complications make most people’s heads spin. That’s not even counting the extortionate fees that real estate agencies might charge. 

Blockchain smart contracts could dramatically streamline this entire process and remove the need for intermediaries entirely. Instead of manually signing every single legal document, you could sign one transaction that would not only constitute a digital signature but also send each document to its appropriate recipient in seconds.

Supply chain diagram.

The supply chain and logistics industry will greatly benefit from smart contract technology in the years to come. Even MIT scholars have been quick to lend their support. One of the key features of blockchain networks is their immutability, meaning that once data is transmitted or stored on-chain, it’s completely un-alterable. It can’t be removed or changed.

A good supply chain is dependent on accurate information. A blockchain solution for supply chain management would automatically record every step of a product’s journey in a completely transparent and immutable way. Businesses save on overhead costs of manually registering this data, while consumers are guaranteed safety and security.

Look at it this way, if a food shipment to your local neighborhood was delayed and spoiled, you’d probably want to know about it to avoid getting sick. A centralized supply chain could alter logistics data to cover its tracks and avoid losses. This information can’t be manipulated on a blockchain, forcing vendor transparency.

What Are The Risks?

Smart contracts are an exciting and creative emerging technology, but they’re still not perfect. While they will undoubtedly streamline many modern processes, smart contracts can still be used with malicious intent.

Example of wallet drainer scam site.

Wallet draining, one of the most common hacks in crypto, is a kind of smart contract. Hackers will set up a fake website, sometimes disguised as a DEX or NFT minting site, and hide a malicious smart contract in the site. If you accidentally approve the transition, you could expose your private key and give a scammer full access to your funds.

Ever noticed how the gas fee for a token swap is generally more expensive than a token transfer to another wallet? That’s because complicated smart contracts demand more attention from validators than simple tasks. Complex smart contracts, especially during periods of network congestion, can be expensive. 

Smart Contract Pros and Cons

It could be argued that the benefits of smart contracts outweigh the drawbacks. Let’s take a look at the pros and cons of smart contracts and their use cases:

Pros

  • Smart contracts automate processes, making them streamlined and frictionless.
  • Smart contracts remove the need for trusted intermediaries, which can be expensive. They also eliminate the potential for human bias and provide equal opportunity for all.
  • Smart contracts are immutable and transparent, giving users greater security
  • When used in decentralized finance, smart contracts can give people access to financial tools and services they were previously excluded from.
  • Modern industries and businesses can be radically improved and made more efficient through smart contract technology

Cons

  • When abused, smart contracts can be used to steal cryptocurrency and other digital assets from unsuspecting users
  • Complicated smart contracts may sometimes require expensive gas fees.
  • Which Blockchain Networks Support Smart Contracts?

Which Blockchain Networks Support Smart Contracts?

Most modern blockchains are designed to support smart contracts; however, the Ethereum blockchain is widely considered the home of smart contract development in the crypto space. Ethereum boasts more blockchain developers and DAOs (decentralized autonomous organizations) than other competing networks.

Most Ethereum smart contracts are written in Solidity, the dominant programming language of the network. Thanks to the interoperability of the EVM (Ethereum Virtual Machine), most Ethereum-based smart contracts can easily be deployed on compatible networks like Avalanche and Polygon.

Solidity isn’t the be-all-and-end-all of smart contract development. Other blockchain networks with different cryptography infrastructures have their own programming languages. For example, smart contracts on Solana are more likely to be written in Rust.

On the Flipside

  • Smart contracts are complicated and dangerous if poorly written and incorrectly used. Good developers can make mistakes in their code, which hackers can exploit.
  • It’s recommended never to interact with unverified or unaudited code. Even code audited by top blockchain security firms might have faults, so you can never be too careful

Why You Should Care

Of all the potential use cases and real-world applications of blockchain technology, smart contracts arguably have the most potential to change how we live in modern society. It’s important to clearly understand what they are and how they work so that you can use them safely.

FAQs

Who invented smart contracts?

While many crypto enthusiasts think that Vitalik Buterin was the inventor of smart contracts, the idea was originally conceived and proposed by Nick Szabo, a computer scientist.

Is Bitcoin a smart contract blockchain?

No, the Bitcoin blockchain does not support smart contracts. However, by wrapping bitcoin and deploying it on other networks like Ethereum, wBTC can be used in smart contracts.

Is Ethereum a smart contract?

Ethereum is a blockchain network that supports smart contract applications and development. Ethereum itself is not a smart contract.

How do smart contracts make money?

Smart contracts can be programmed to take a small percentage or amount of cryptocurrency from any transaction that passes through it. Alternatively, smart contract development is a sought-after skill in the crypto job market that commands high salaries.

Can blockchain work without smart contracts?

Some blockchains like Bitcoin and XRP don’t support smart contracts and are still fully operational.

This article is for information purposes only and should not be considered trading or investment advice. Nothing herein shall be construed as financial, legal, or tax advice. Trading forex, cryptocurrencies, and CFDs pose a considerable risk of loss.

Author
Finn Miller

Finn Miller is a New Zealand-based blockchain writer for DailyCoin who specializes in simplifying complex blockchain topics. He is experienced in crafting whitepapers, researching on-chain data, and advising emerging crypto projects, and uses his unconventional approach to learning and passion for knowledge to provide cornerstone educational content for readers of all levels. When not exploring the depths of DeFi, Finn can be found exploring his other passion, the great outdoors.