What Are Smart Contracts and How Do They Work?
Smart contracts were first described in the 1990s by Nick Szabo. He defined a smart contract back then as a mechanism for formalising and securing computer networks through the use of protocols and user interfaces.
Szabo explained how smart contracts could be used in a variety of industries involving contractual agreements, including credit systems, payment processing, and content rights management. These contracts are an application or programme that operates on a blockchain in the realm of cryptocurrency. Typically, they function as a digital agreement governed by a set of rules. Computer code defines these rules, which are duplicated and executed by all network nodes.
Smart contracts on the blockchain enable the establishment of trustless systems. This means that two parties can create promises on the blockchain without knowing or trusting one another. They can be assured that if the terms aren’t met, the deal will not be carried out. Aside from that, these contracts can eliminate the need for intermediaries, drastically lowering operational costs.
Although the Bitcoin protocol has supported smart contracts for many years, they were popularised by Vitalik Buterin, the creator and co-founder of Ethereum. It’s worth mentioning, though, that each blockchain may use a different approach to smart contract implementation.
The smart contracts that operate on the Ethereum Virtual Machine (EVM), which is a critical component of the Ethereum blockchain, will be the topic of this essay.
How do they function?
In simple terms, a these contracts are a deterministic piece of software. When and if certain circumstances are met, it performs a specific task. As a result, “if… then…” expressions are frequently used in smart contract systems. Contrary to popular belief, smart contracts are neither legal nor smart contracts. They are nothing more than a piece of code that runs on a distributed system (blockchain).
These contracts are in charge of performing and managing blockchain actions that occur when users (addresses) engage with one another on the Ethereum network. An externally held account is any address that isn’t a smart contract (EOA). EOAs are governed by users, while smart contracts are controlled by computer code.
Ethereum smart contracts are made up of two public keys and a contract code. The initial public key is that provided by the contract’s creator. The contract itself is represented by the other key, which serves as a digital identity for each contract.
Any contract must be deployed via a blockchain transaction, and they can only be executed when triggered by an EOA (or by other contracts). An EOA, on the other hand, is always the first trigger (user).
Characteristics
The following are common properties of an Ethereum smart contract(SM)
Distributed. The Ethereum network’s SM’s are duplicated and disseminated across all nodes. This is one of the primary differences from other centralised server-based solutions.
Deterministic SM’s only carry out the tasks for which they were created, as long as the conditions are met. Furthermore, regardless of who implements them, the result will always be the same.
Autonomous SM’s, which behave like a self-executing computer, may automate a wide range of tasks. In most circumstances, though, if a smart contract isn’t activated, it will remain “dormant” and do nothing.
Immutable After they’ve been deployed, smart contracts can’t be altered. Only if a certain function was previously implemented can it be “removed.” As a result, SM’s can provide tamper-resistant coding.
Customizable. SM’s can be coded in a variety of ways before being deployed. As a result, they can be utilised to build a variety of decentralised applications (DApps). This is due to Ethereum’s status as a Turing-complete blockchain.
Trustless. SM’s allow two or more parties to engage without knowing or trusting one another. Furthermore, blockchain technology ensures data accuracy.
Transparent because SM’s are built on public blockchains, their source code is not only immutable but also public.
Is it possible to edit or delete a smart contract?
After an Ethereum smart contract has been launched, it is hard to add additional functionalities. If the smart contract’s developer includes a function called SELFDESTRUCT in the code, they will be able to “destroy” it in the future and replace it with a new one. They won’t be able to delete the method, though, if it wasn’t included in the code earlier.
Notably, so-called upgradeable smart contracts give developers additional control over the immutability of contracts. Upgradeable smart contracts can be created in a variety of ways, each with varying degrees of difficulty.
Let’s pretend that a smart contract is partitioned into numerous smaller contracts as an example. Some are supposed to be unchangeable, while others have the ability to be deleted. This means that a portion of the code (smart contracts) can be removed and replaced while the rest of the code remains functional.
Benefits and applications
Smart contracts, being programmable code, are extremely flexible and may be designed in a variety of ways to provide a variety of services and solutions.
Smart contracts, as decentralised and self-executing programmes, may offer improved transparency and lower operational expenses. They can also improve efficiency and cut bureaucratic costs, depending on how they’re implemented.
Smart contracts are especially beneficial in cases where two or more parties must transfer or trade funds.
To put it another way, smart contracts can be tailored to a wide range of scenarios. Tokenized assets, voting systems, crypto wallets, decentralised exchanges, games, and mobile applications are just a few examples. They could also be used in conjunction with other blockchain technologies for healthcare, charity, supply chain, governance, and decentralised finance (DeFi).
ERC-20 Tokens issued on the Ethereum network adhere to the ERC-20 standard. All Ethereum-based tokens’ essential functions are described in the standard. As a result, these digital assets are commonly referred to as ERC-20 tokens, and they make up a significant component of the cryptocurrency market.
Many blockchain enterprises and startups use smart contracts to issue their digital tokens on the Ethereum network. Following the issue, the majority of these companies used Initial Coin Offering (ICO) events to distribute their ERC-20 tokens. In most cases, smart contracts make it possible to swap funds and distribute tokens in a trustless and efficient manner.
Limitations
Smart contracts are made up of human-written computer code. As a result, there are several dangers because the code is vulnerable to errors and vulnerabilities. In an ideal world, they would be designed and deployed by skilled programmers, especially when dealing with sensitive data or large sums of money.
Aside from that, some say that centralised systems can provide most of the smart contract’s solutions and features. Smart contracts, on the other hand, execute on a distributed P2P network rather than a centralised server. And, because they’re built on the blockchain, they’re either immutable or extremely difficult to change.
Being unchangeable might be beneficial in some situations but detrimental in others. Millions of ether (ETH) were stolen, for example, when a decentralised autonomous organisation (DAO) dubbed “The DAO” was hacked in 2016 due to flaws in their smart contract design.
Developers were unable to fix the code since their smart contracts were immutable. This resulted in a hard fork, resulting in the formation of a second Ethereum chain. To put it another way, one chain “reverted” the hack and restored the funds to their rightful owners (this is part of the current Ethereum blockchain). The other chain chose not to intervene in the hack, claiming that events on a blockchain should never be altered (this chain is now called Ethereum Classic).
It’s worth noting that the issue was not caused by the Ethereum blockchain. Instead, a defective smart contract implementation was to blame.
Another disadvantage of smart contracts is their ambiguous legal status. Smart contracts are not only illegal in most countries, but they also don’t fit into the current legal structure.
Many contracts, for example, demand that both parties be properly identified and over the age of 18. The lack of intermediaries paired with the pseudonymity afforded by blockchain technology may jeopardise those criteria. While there are potential solutions, the legal enforceability of smart contracts is a significant challenge, particularly in borderless, distributed networks.
Criticism
Smart contracts, according to some blockchain proponents, will soon replace and automate a large portion of our commercial and bureaucratic institutions. While this is a feasible scenario, it is unlikely to become the norm.
Smart contracts are undoubtedly a fascinating piece of technology. However, in other cases, their distributed, deterministic, transparent, and relatively immutable nature can make them less appealing.
The main point of contention is that smart contracts aren’t a good fit for a lot of real-world problems. In fact, some businesses would be better suited to sticking with traditional server-based solutions.
Compared to smart contracts, centralised servers are simpler and less expensive to maintain, and they tend to be more efficient in terms of speed and cross-network communication (interoperability).
Conclusions
Smart contracts have undoubtedly had a significant impact on the world of cryptocurrencies, and they have undoubtedly transformed the blockchain sector. Smart contracts will likely enable a wide range of applications in the future, ranging from financial services to supply chain management, even if end-users do not interact with them directly.
Smart contracts and blockchain, when used together, have the ability to alter practically every aspect of our civilization. However, only time will tell if these ground-breaking technologies will overcome the numerous challenges to wide-scale implementation.
