A Deep Dive Into Smart Contracts and How They Work?

Table of Content:

1. What are smart contracts
2. How do smart contracts work
3. Limitations of smart contracts
4. Use cases of Smart Contracts?
5. Conclusion

Today’s world has gotten everyone more than familiar with apps and app stores. You search, you download the app you want, and you move on to look for the other. Behind the attractive UX and UI interfaces of mobile devices, these applications work by performing a specific set of instructions as intended.

In the world of Web3 applications, often termed decentralized applications, this set of instructions is termed Smart Contracts.

Today’s article discusses the basics of smart contracts, how they work, and a lot more. Keep reading till the end to learn!

In brief

• Smart contracts are self-executing contracts in which the contents of the buyer-seller agreement are inscribed directly into lines of code.
• Dapps, or decentralized apps, are essentially a series of linked smart contracts.
• Smart contracts are being used to power hundreds of popular DeFi protocols.

Now, let's find out what are smart contracts.

What are Smart Contracts?

In the simplest terms, a smart contract is a piece of code, designed to carry out a set of instructions.

A smart contract is an agreement between two people or entities in the form of computer code programmed to execute automatically. Nick Szabo, a pioneer of modern computer science, proposed the idea of smart contracts in the 1990s. He defined them as a set of virtual promises with associated protocols to enforce them.

Smart contracts and Blockchain; are never without each other!

Why so? Let’s find out!

Smart contracts are made possible by blockchains, a network of computers that work together to enforce rules on the network without any intermediary. Smart contracts are executed on the blockchain, implying that the instructions are stored in a distributed database and cannot be altered. Transactions are also processed on the blockchain, which automates payments and counterparties.

The Bitcoin protocol, which records the proof of payment, can be seen as a primitive version of a smart contract. Ever since the emergence of Ethereum, the fundamentals of smart contracts have been streamlined, as complex transactions can be programmed into the Ethereum protocol.

Smart contracts eliminate middlemen. No person or company is holding your information or verifying it. The blockchain verifies and holds information for you. Vitalik Buterin, and the Ethereum community, believe that this is the future of the blockchain.

Often quoted, “If Bitcoin is the gold of the business world, smart contracts are the oil the business world runs on.”

So much on smart contracts, just how do they work, then?

How Do Smart Contracts Work?

A smart contract is a program that encodes business logic and operates on a dedicated virtual machine embedded in a blockchain or other distributed ledger. It makes it possible to automate digital tasks such as transferring money, buying/selling assets, and even playing games, without needing a centralized entity to manage and approve the transactions.

Smart contracts work on the simple concept of “if/when…then…” statements, written into code on a blockchain. A network of computers executes the actions when predetermined conditions have been met and verified. These actions may comprise releasing funds to the appropriate parties, registering a vehicle, sending notifications, or issuing a ticket. The blockchain is then updated when the transaction is completed.

To put it into perspective, here are the steps it follows:

1. A criterion for the smart contract’s desired behavior in response to certain events or circumstances is defined.
2. The developers then use a smart contract writing platform to create and test the logic.
3. Once the code writing is complete, it is sent to a separate team for security testing. An internal expert or a company that specializes in vetting smart contract security is appointed.
4. The smart contract is then deployed on an existing blockchain or other distributed ledger infrastructure once it has been authorized.
5. The smart contract is configured to listen for event updates from an “oracle,” which is effectively a cryptographically secure streaming data source, post-deployment.
6. Once it obtains the necessary combination of events from one or more oracles, the smart contract executes.

Some notable DApps

• MakerDAO — A decentralized finance (DeFi) app that enables users to lend and borrow cryptocurrencies without needing a middleman.
• Uniswap — An Ethereum-based exchange that allows anyone to swap ERC-20 tokens.
• Axie Infinity — a play-to-earn game in which players collect and breed monsters, represented by NFTs, and battle with them.
• Argent — an Ethereum wallet that uses smart contracts to abstract away concepts like addresses and private keys.

Thousands of apps that use smart contracts are already up and running successfully. Popular Ethereum apps MakerDAO and Compound use smart contracts at their core for lending and allowing users to earn interest. Apart from finance, a variety of industries could benefit from using blockchain-based smart contracts as part of their supply chains.

Limitations of Smart Contracts

Despite being considered to be a “trustless” way of enforcing agreements and logic, smart contracts aren’t without their fair share of problems.

For starters, smart contracts are immutable. This implies that once deployed, they cannot be modified or upgraded, which can lead to catastrophic consequences if the code consists of underlying issues, usually ending with investors losing money.

Although smart contracts seek to eliminate third-party involvement, it is not possible to eliminate them entirely. Third parties assume different roles from the ones they take in traditional contracts. For example, lawyers will not be needed to prepare individual contracts; however, they will be needed by developers to understand the terms to create codes for smart contracts.

Use cases of Smart Contracts?

Smart contracts are at the heart of the entire decentralized finance (DeFi) revolution and are used to power hundreds of popular DeFi protocols. However, there has also been mass adoption by a whole host of corporations, and even some governments.

Smart contracts have applications in all areas where traditional contracts are currently signed such as:

Records

Smart contracts can facilitate the storage and maintenance of records. For example, maintenance of the millions of confidential patient records that need to be securely stored and updated.

Trade

Most commercial activities rely on the approval of their funding, which is a time-consuming and resource-intensive process. With smart contracts, this time can be dramatically reduced.

Supply chains

Internet of Things devices can be used throughout the supply chain to record every step of a product and improve its traceability. In this way, errors, theft, and loss can be eliminated.

Mortgages

Mortgage transactions based on smart contracts can be made cheaper, faster, and safer. This will allow buyers to access the property earlier and update the records automatically.

Property Market

Smart contracts can be used to register property ownership more efficiently. Moreover, their use can extend beyond flats, buildings, or land and register all types of assets.

Some of the most prominent examples include:

• Ubisoft: Video games giant Ubisoft has embraced blockchain in a big way; it has drafted specially designed smart contracts allowing users to own, transfer, and claim rare NFTs based on its popular Rabbids gaming franchise.
• ING: Dutch bank ING has co-created Fnality, a blockchain-based trade-settlement system using smart contracts.
• The Swedish government: Sweden’s government has tested a blockchain-based land registry for proving the ownership of land, which is built on smart contracts.

But…there’s always a BUT, eh?

Smart contracts aren’t always perfect…

Conclusion

Nowadays, most blockchains employ smart contracts. With active communities of developers creating DeFi and Web3 applications using smart contracts, the scope of smart contract capabilities ranges from very simple based on something like Bitcoin or Litecoin, to more advanced on dApp-capable blockchains like Ethereum and Polkadot.

However, we’re still in the early days of what smart contracts can potentially offer. But there are companies and even governments experimenting with their potential. In the coming years, we can expect industries to tap deeper into the millions of possibilities of smart contracts!

About ImmuneBytes

We at ImmuneBytes offer enterprises and startups comprehensive smart contract auditing solutions for their applications to have a secure commencement. Our journey begins with an aim to foster security in the upcoming blockchain world, improving the performance of large-scale systems.

ImmuneBytes administers stern smart contract audits, employing static and dynamic analysis and examining a contract’s code and gas optimization, leaving no escape route for bugs.

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