Smart contracts are self-executing lines of code that facilitate automated transactions and agreements between parties. They are a key underlying technology enabling the decentralized models emerging across finance, organizations, governance, and more.
In this article, we take a deep dive into this revolutionary tech; its basics, history, and functionality.
Smart Contract Basics
At a basic level, a smart contract is software code that runs on a blockchain network to execute predefined rules and digital agreements automatically once deployed.
One of the key attributes of a smart contract is that it is deployed on blockchains that run exactly as programmed without centralized intermediaries. This could be a double-edged sword as some projects have lost millions of dollars to smart contract errors. It is estimated that more than $1 billion worth of Ether has been lost forever due to smart contract bugs and human errors.
Some other core features of a smart contract is:
- The code defines business logic and rules like payment transfers based on if-then conditions being met.
- They enable trustless automation between mutually distrusting counterparties.
- Smart contracts displace traditional legal contracts by directly encoding agreements in digital form.
- They expand the capabilities of blockchains beyond simply storing data.
The core innovation of smart contracts is enabling digital relationships and agreements without requiring trusted intermediaries.
History and Origins
Surprisingly, the concept of smart contracts predates blockchain. The idea of encoding legal agreements as software code was first described in the 1990s by computer scientist Nick Szabo. This means that several attempts were made to build smart contract systems before Bitcoin and blockchain technology even existed.
Early digital cash protocols like Bit Gold explored programmable money enforced by code rather than counterparties. However, the launch of Bitcoin and its underlying blockchain innovation proved a key enabler for smart contracts to practically function at global scale due to its distributed digital ledger providing trusted data inputs, consensus mechanisms enabling agreement between untrusting entities, and an open platform allowing anyone worldwide to access and build smart contracts.
Bitcoin itself utilized basic smart contract functionality for features like multi-signature accounts. But the launch of Ethereum expanded smart contract capabilities dramatically into a Turing-complete programming language.
How Smart Contracts Work
Under the hood, smart contracts execute through the following steps:
- They are created in a specialized coding language optimized for blockchain execution like Solidity.
- The smart contract code gets compiled into bytecode that is deployed and uploaded to the blockchain network.
- Users submit transactions to execute specific functions defined in the deployed contract.
- The network’s miners or validators execute the contract’s code with inputs from the transaction.
- The execution updates the contract’s state if conditions programmed are satisfied.
- The final state change and any outputs get recorded immutably on the blockchain after consensus.
This provides deterministic and verifiable contract execution without middlemen.
Smart Contract Capabilities
Some examples of what smart contracts unlock:
- Programmable money – Embed conditions on how payments can be spent like release schedules, limits, reciprocity requirements etc.
- Digital assets – Tokenize any scarce resource or asset via smart contracts that control issuance and provenance.
- Decentralized finance – Enable transparent and programmable financial services without intermediary institutions.
- Supply chain – Embed business terms, origin tracing, and vendor controls into digital representations of tradeable assets.
- Voting mechanisms – Create transparent binding votes and elections executed automatically based on coded rules.
- Identity – Store and share verified credentials like diplomas, certifications, and attestations in tamper-proof digital form.
Public Blockchain Smart Contracts
On public blockchains like Ethereum, Bitcoin, and BSC, anyone can deploy open smart contracts. Public chain advantages include:
- Permissionless innovation – Open environment fosters more creativity and entrepreneurship.
- Transparency – Contract code is viewable openly by all on public ledgers.
- Censorship resistance – Public sharing prevents censorship or limiting access to contracts.
- Immutable records – State changes get permanently recorded on the blockchain.
- Global coordination – Public contracts unlock collaboration between mutually distrusting entities worldwide.
- Composability – Contracts can readily build on and integrate with one another in public environments.
Public smart contracts facilitate new models of open participation and cooperation on a global scale.
Private Blockchain Smart Contracts
Conversely, private blockchains controlled by known participants also utilize smart contracts with benefits like:
- Known identities – Avoiding interactions with anonymous users and limited privacy.
- Controlled access – Limiting which parties can view data or execute transactions.
- Efficiency – Lower costs and faster execution by limiting decentralization’s redundancies.
- Compliance – Adherence with regulations around data and transaction monitoring.
- Provenance tracing – Documentation of all entities interacting with private contracts.
- Accountability – Smart contracts tied to real identities rather than pseudonyms.
Private environments provide assurances for sensitive contexts, albeit with some decentralization tradeoffs.
Programming Smart Contracts
Popular languages used to code smart contracts include:
Solidity – The main smart contract language for Ethereum. Similar syntax to JavaScript.
Vyper – A Python-inspired language focused on security and auditability.
Clarity – The Lisp-based smart contract language used in the Stacks blockchain.
Chaincode – The Go-based smart contract language supported by Hyperledger Fabric.
Rust – The Rust language via the Solang compiler enables writing contracts safe from vulnerabilities.
Different languages have unique strengths based on goals around accessibility, security, and performance.
Decentralization Use Cases
Some key examples of smart contract decentralization capabilities:
DAOs – Smart contracts enable decentralized autonomous organizations to codify governance, voting, and funding in transparent and tamper-proof ways.
DeFi – Decentralized finance built on smart contract “money legos” providing services from lending and derivatives to token exchanges trustlessly.
NFTs – Non-fungible tokens representing unique digital assets like art and collectibles with ownership and transfer logic programmatically enforced.
Identity – Self-sovereign identity and verifiable credentials remove reliance on central authorities vouching for user attributes.
Supply Chain – Documents movements and transactions of goods immutably on public ledgers for transparency and automation.
Insurance – Algorithmic models calculate payouts automatically when pre-defined conditions are triggered to speed claims.
These demonstrate how smart contracts are fueling the emergence of decentralized paradigms across industries.
Code Immutability Considerations
An important nuance around blockchain smart contracts involves code immutability:
- Smart contracts are immutable by design once deployed, unlike web applications that can be updated.
- This prevents tampering but introduces risks if undiscovered bugs exist in the initial programming.
- Major exploits have occurred due to vulnerable code passing audits and tests but exposed later during usage at scale.
- Strategies to mitigate include upgradeable contracts that redirect control flow to new contracts when needed.
- Hybrid architectures with off-chain components also contain damage from on-chain issues.
Blending immutability with prudent upgradeability expands smart contract potential.
Oracle Reliability
Smart contracts rely on external data inputs called oracles:
- Oracles introduce information like market prices, IoT data, random numbers etc. into deterministic contract logic.
- Issues emerge if oracle problems provide bad data that corrupts contract outcomes.
- Solutions include decentralized oracles, redundant data sources, and efficient dispute processes to detect and rectify inaccurate feeds.
Robust oracles prevent faulty inputs from corrupting otherwise sound smart contract execution.
Conclusion
Smart contracts are a breakthrough concept enabled by blockchain infrastructure that is powering a new generation of decentralized digital agreements and automation. By directly embedding the terms, permissions, constraints, and business logic of relationships and transactions in software code, smart contracts enable trustworthy peer-to-peer coordination at global scale. They are a foundational primitive spurring decentralized transformation across industries as developers build increasingly sophisticated and meaningful applications upon them. Despite challenges around issues like security and upgradeability that remain areas of innovation, smart contracts represent a paradigm shift in how to structure agreements and organizations. Their disruptive potential continues growing as blockchain adoption accelerates.
