What Are Smart Contracts?

Basics

In the 1990s, Nick Szabo introduced the concept of smart contracts. He defined them as tools that combine protocols with user interfaces to secure computer networks. Szabo suggested using smart contracts in various fields involving contractual agreements, including credit systems, payment processing, and content rights management.

In the realm of cryptocurrencies, smart contracts can be considered programs or applications running on a blockchain. Typically, they operate as digital agreements enforced by predefined rules in computer code. All network nodes replicate and execute this code.

Smart contracts on a blockchain allow for trustless protocols, enabling two parties to commit via blockchain without knowing or trusting each other. They can be confident that the agreement will not execute if the conditions aren't met. Additionally, smart contracts eliminate the need for intermediaries, reducing operational costs significantly.

Although Bitcoin has supported smart contracts for years, the founder of Ethereum, Vitalik Buterin, made them really popular. However, different blockchains may have unique ways of implementing smart contracts.

This article will focus on smart contracts running on the Ethereum Virtual Machine (EVM), a crucial component of the Ethereum blockchain.

How Do Smart Contracts Work? 

When certain conditions are met, a smart contract executes a particular task, working as a deterministic program. A smart contract system follows "if… then…" statements. However, despite their name, smart contracts are neither smart nor legal contracts; they are a piece of code running on a distributed system like a blockchain.

Smart contracts on the Ethereum network execute and manage blockchain operations when users (addresses) interact. Addresses that are not smart contracts are externally owned accounts (EOA) controlled by users, whereas smart contracts are controlled by computer code.

Ethereum smart contracts have two components: contract code and two public keys. The first key is provided by the creator of the contract, and the other key represents the contract itself, serving as a unique digital identifier.

Smart contracts are deployed via a blockchain transaction and are only activated when called by an EOA or other smart contracts. However, an EOA always triggers the first activation.

Key Features of Smart Contracts 

Smart contracts on the Ethereum network have the following key features:

• They are distributed and replicated in all nodes of the network, unlike solutions based on centralized servers.
• They are deterministic and will only perform their designated actions when requirements are met. The outcome will be the same regardless of who executes them.
• They are autonomous and can automate tasks as a self-executing program. However, if not triggered, they will remain inactive.
• They are immutable, meaning they can't be modified after deployment, but can be "deleted" if a specific function was implemented. This provides tamper-proof code.
• They are customizable and can be coded in various ways before deployment, making them helpful in creating various types of decentralized applications (DApps). This is due to Ethereum being a Turing-complete blockchain.
• They are trustless, allowing two or more parties to interact without prior knowledge or trust. Blockchain technology ensures data accuracy.
• They are transparent since they are based on a public blockchain, meaning their source code is visible to everyone.

Is It Possible to Modify or Delete a Smart Contract?

Modifying or deleting an Ethereum smart contract after deployment is not possible. The SELFDESTRUCT function is the only way to "delete" a contract, but it must be included in the code during creation. If the function is absent, the contract is immutable and cannot be deleted. However, developers can create upgradeable smart contracts that offer more flexibility by dividing the code into smaller contracts. Some of these contracts can be deleted and replaced, while others remain immutable. The process of creating upgradeable smart contracts can vary in complexity.

Use Cases and Benefits of Smart Contracts

Smart contracts offer various advantages and use cases due to their programmable nature. They can be designed in multiple ways to offer different services and solutions. As decentralized and self-executing programs, smart contracts provide increased transparency and reduced operational costs while increasing efficiency and decreasing bureaucratic expenses.

Smart contracts are particularly useful in scenarios involving the transfer or exchange of funds among multiple parties. They can be utilized for various use cases, such as creating tokenized assets, voting systems, crypto wallets, decentralized exchanges, games, and mobile applications. Additionally, they can be deployed in tandem with other blockchain solutions to address fields such as healthcare, charity, supply chain, governance, and decentralized finance (DeFi). In summary, smart contracts are highly customizable and can be designed to offer many different services and solutions.

ERC-20 Tokens

The Ethereum blockchain is the foundation for many tokens that are standardized according to the ERC-20 specification. Such tokens are often referred to as ERC-20 tokens and comprise a significant proportion of the current cryptocurrency market.

Numerous startups and blockchain firms have utilized smart contracts to create their own tokens on the Ethereum network, with Initial Coin Offering (ICO) events being the typical distribution method. By incorporating smart contracts into the ICO process, companies can handle the exchange of funds and distribution of tokens in an efficient and secure manner that does not require trust between parties.

Limitations 

The decentralized and programmable nature of smart contracts offers many advantages, such as increased transparency and efficiency, reduced costs, and a wide range of use cases. However, there are also some limitations to be aware of.

One limitation is the risk of vulnerabilities and bugs due to human-written code. To minimize these risks, it is advisable to have experienced programmers who write and deploy smart contracts, particularly when sensitive information or large amounts of money are involved.

Moreover, centralized systems can offer similar functionalities to smart contracts. The main difference is that smart contracts run on a distributed P2P network, making them immutable or at least hard to change. While immutability can be beneficial in certain situations, it can also be detrimental in others. For instance, when The DAO was hacked in 2016 due to flaws in its smart contract code, millions of ETH were stolen. The immutability of the contract prevented developers from fixing it, leading to a hard fork and the creation of a second Ethereum chain.

Another limitation is the uncertain legal status of smart contracts, which do not always comply with current legal frameworks. For example, some contracts require proper identification and age verification of both parties, which may be threatened by the pseudonymity and lack of intermediaries provided by blockchain technology. This legal enforceability challenge is especially relevant for borderless and distributed networks.

A Critical View of Smart Contracts 

The potential of smart contracts to replace and automate commercial and bureaucratic systems is a popular idea among blockchain enthusiasts. However, this reality may not be feasible for many real-world problems due to the limitations of smart contracts.

While smart contracts are a fascinating technology, their distributed, deterministic, transparent, and immutable nature may make them less appealing in some situations. As a result, some organizations may find it more effective to use conventional server-based alternatives instead of smart contracts.

One of the main criticisms of smart contracts is their unsuitability for certain use cases. Centralized servers, in comparison, are easier and more cost-effective to maintain and offer greater efficiency in terms of speed and cross-network communication.

Conclusion

Smart contracts have transformed the blockchain industry, causing a significant impact on cryptocurrencies. Although users do not typically interact with smart contracts directly, they have the potential to power a wide variety of applications, from financial services to supply chain management.

Smart contracts and blockchain have the potential to revolutionize society, but it remains to be seen whether these groundbreaking technologies will be able to overcome the obstacles to widespread adoption.