Understanding Smart Contracts – A Beginner's Guide
Definition of Smart Contracts
A smart contract is a self-executing computer program with the terms of the agreement written directly into lines of code. It is stored and replicated on a blockchain network. Smart contracts enable the creation of trustless and decentralized systems, as the terms of the contract are verifiable, and the execution of the contract is automatic.
Trustless systems are those in which two parties can transact without the need to trust each other. Decentralized systems are those in which power or authority is distributed among multiple actors rather than concentrated in a single central point. Together, trustless decentralized systems refer to systems in which the power and authority is distributed among multiple actors and parties can transact without the need to trust each other.
How Smart Contracts Work
Smart contracts use blockchain technology to create a digital ledger that records all transactions. The terms of the contract are encoded into the code, and the execution of the contract is automatic when certain conditions are met. For example, when a certain number of parties have signed the contract, or when a certain date or event has occurred. This eliminates the need for intermediaries, such as lawyers or banks, to verify and enforce the contract.
The technical complexity of smart contracts can be broken down into several key elements:
Blockchain: Smart contracts are typically built on top of a blockchain network, which is a decentralized and distributed ledger technology. This means that all nodes in the network have a copy of the same ledger and transactions are recorded in blocks that are linked together in a chain. This creates a tamper-proof and transparent record of all transactions.
Smart Contract Code: Smart contracts are written in a high-level programming language such as Solidity (for Ethereum), Go (for EOS), or Chaincode (for Hyperledger Fabric), which are specifically designed for smart contract development. The code is then compiled into bytecode, which can be executed on the blockchain where it is stored and replicated across the network, i.e., it becomes a part of the blockchain's ledger.
Once the smart contract is deployed on the blockchain, it can be invoked by sending a transaction to its address on the network. This transaction contains the input data required by the smart contract to trigger its execution. The smart contract then performs the actions specified in its code, such as transferring funds from one account to another or updating the state of a digital asset.
Conditions and Logic: Smart contracts are designed to automatically execute when certain conditions are met. These conditions are built into the code of the smart contract, and they determine when the contract will execute. For example, a smart contract for a crowdfunding campaign might be set to automatically distribute funds to the project creator once the fundraising goal has been reached.
Input Data: Smart contracts require input data in order to execute. This data is often provided by sources, such as an API or an oracle, and it is used to determine whether the conditions for execution have been met. In the context of smart contracts, an API (Application Programming Interface) is a set of programming instructions that allows different software systems to interact with each other. An oracle, on the other hand, is a service or system that provides external data to a smart contract.
An API allows a smart contract to access external data or functionality, such as data from a database or information from a web service. An oracle, which can be thought of as a specialized type of API, is a way for a smart contract to access data from the outside world, such as the current price of a stock or the temperature in a specific location. Oracles are used to provide external data to smart contracts, which can then use that data to execute their terms. For example, an oracle might provide a smart contract with the current temperature, which the smart contract then uses to determine whether to execute a weather insurance contract.
Execution: Once the conditions of a smart contract have been met and the necessary input data has been provided, the smart contract will automatically execute. This can include transferring funds, updating data on the blockchain, or triggering other smart contracts.
Smart contract state: Smart contract state refers to the current state or status of the smart contract. It can be used to check the current state of the contract, change the state, or track the history of the state changes
Benefits of Smart Contracts
Proponents of smart contract technology emphasize these benefits:
Increased Efficiency and Automation: Smart contracts automate the process of executing a contract, reducing the time and resources required to complete a transaction. This can lead to significant cost savings and increased speed of execution, as well as reducing human error and the possibility of disputes.
Improved Security and Transparency: Smart contracts are stored on a blockchain, which is a secure and transparent digital ledger. This means that all parties have access to the same information and can see the contract's execution in real-time. Additionally, smart contracts are immutable, meaning that once they are deployed, they cannot be altered. This improves security by eliminating the risk of fraud or manipulation and provides a tamper-proof record of the transaction, which can be used for auditing and regulatory compliance. An example of this is in supply chain management, where smart contracts can be used to track the movement of goods and ensure that all parties are adhering to the agreed-upon terms.
Cost Savings and Reduced Risk: Smart contracts eliminate the need for intermediaries, such as lawyers or banks, to verify and enforce the contract. This can lead to significant cost savings and reduced risk of errors or fraud. Additionally, because they are stored on a blockchain, they can be executed with a high level of trust and security, which reduces the risk of fraud or errors. For example, in the insurance industry, smart contracts can be used to automate claims processing, reducing the need for manual labor and improving the overall efficiency of the claims process.
Challenges and Limitations of Smart Contracts
Critics argue that smart contracts are too complex to be widely adopted, that there is a lack of expertise in the field, and that the technology faces scalability and interoperability issues. Additionally, smart contracts are not yet legally recognized as enforceable agreements in many jurisdictions, and critics argue that the trustless nature of smart contracts on a blockchain is not a big advantage.
Smart contracts are also inflexible and limited in their functionality, and currently can't handle complex scenarios, plus they can have privacy and confidentiality issues (smart contracts are public and open, which can be a problem for agreements that need to be kept private: it's difficult to keep private information secure on a public blockchain).
Critics of blockchain technology in general also argue that smart contracts are no more than an overhyped version of traditional legal agreements and that the trustless nature of smart contracts on a blockchain is not a big advantage as the trust is shifted to the underlying technology and its governance.
There are three main areas of concern that currently hamper widespread adoption of smart contracts:
1. Legal and Regulatory Issues
Smart contracts are still a relatively new technology, and there are currently no clear regulations in place for their use. This can create uncertainty for businesses and individuals looking to use smart contracts and may be a barrier for widespread adoption.
There are several legal and regulatory issues surrounding the use of smart contracts, including:
Legal recognition: In many jurisdictions, smart contracts are not yet legally recognized as enforceable agreements. This means that there may be uncertainty around the enforceability of smart contracts in the event of a dispute.
Jurisdiction: Smart contracts are often executed on decentralized networks, which raises questions around jurisdiction and the applicable law in case of a dispute.
Smart Contract Design: Smart contract design is critical, as poorly designed smart contracts can lead to unintended consequences or errors. Smart contract creators must be aware of the legal implications of their design choices and the need for proper testing and auditing.
Compliance: Smart contracts must comply with the same laws and regulations that apply to traditional contracts. This includes laws related to data privacy, money laundering, and other financial regulations.
Risk Management: Smart contracts rely on the underlying blockchain infrastructure, which means that if the blockchain is compromised or experiences an outage, the smart contract may not execute as intended.
Liability: In case of errors or bugs in a smart contract, it may be difficult to determine liability and responsibility.
Interoperability: Smart contracts are often developed on different blockchain platforms and may not be easily interoperable with each other. This can create challenges when it comes to integrating smart contracts into existing systems and processes.
It is important to note that laws and regulations regarding smart contracts vary by jurisdiction and are still evolving. Therefore, it is important to consult with legal and regulatory experts to ensure compliance with applicable laws and regulations when using smart contracts.
2. Scalability and Adoption
Smart contracts are still in the early stages of adoption, and there are currently limitations on their scalability. This can make it difficult for businesses to implement smart contracts at a large scale, as well as on the number of transactions that can be processed per second.
Solutions like sidechains, sharding, and off-chain computation are being developed to address scalability issues and improve the performance of smart contracts. Additionally, there is ongoing work to develop standards and best practices for smart contract design and development to help facilitate wider adoption.
Currently, there are several scalability and adoption issues with the use of smart contracts:
Scalability: Smart contracts are executed on decentralized networks, which can lead to scalability issues as the number of transactions increases. This is because all nodes in the network must process and validate each transaction, which can lead to slow transaction times and high fees.
Performance: Smart contracts are executed by the nodes on a blockchain network, and the performance of these nodes can affect the performance of the smart contract. If the nodes are not powerful enough, the smart contract may not execute as intended.
Interoperability: Smart contracts are often developed on different blockchain platforms and may not be easily interoperable with each other. This can create challenges when it comes to integrating smart contracts into existing systems and processes (or other smart contracts).
Complexity: Smart contracts can be complex to design and implement, which can be a barrier to adoption for some organizations. This complexity can also increase the risk of coding errors or bugs in the smart contract.
Standards: There are currently no widely accepted standards for smart contract design and development, which can make it difficult for organizations to adopt and implement smart contracts.
Lack of expertise: There is a lack of expertise in the field of smart contract design and development, which can be a barrier to adoption for some organizations.
Lack of public awareness: Smart contract is still a relatively new technology and lack of public awareness of its capabilities and benefits can be an obstacle for its adoption.
3. Technical Complexity
The technical complexity of smart contracts varies depending on the specific implementation and use case, and not all individuals and businesses have the resources or expertise to implement them. This can limit their adoption and use, especially for non-technical individuals and small businesses.
The technical complexity of smart contracts depends on the complexity of the logic and the functionality required, as well as the specific blockchain platform being used. For example, smart contracts on the Ethereum blockchain have more functionality and flexibility than those on other blockchain platforms, but also require more complex code.
Smart contract coding languages are not as mature as traditional programming languages and can lead to vulnerabilities and errors in the smart contract code, making smart contracts only as secure as the code they are written in.
Application Examples of Smart Contracts
There are many examples of how smart contracts could be used. Here is a selection:
Real Estate: Smart contracts can be used to automate the process of buying and selling property, including the transfer of ownership and payment of funds. For example, a smart contract could automatically transfer ownership of a property from the seller to the buyer once the agreed-upon purchase price has been paid. This eliminates the need for intermediaries and manual processes, leading to increased efficiency and cost savings. Read more: Blockchain in Real Estate.
Supply Chain Management: Smart contracts can be used to track the movement of goods and ensure that all parties are adhering to the agreed-upon terms. For example, a smart contract can be used to track the delivery of goods from the manufacturer to the retailer, automatically releasing payment to the manufacturer once the goods have been delivered and accepted. This improves transparency and security in the supply chain. Read more: Using blockchain to drive supply chain transparency.
Insurance: Smart contracts can be used to automate the claims process, reducing the need for manual labor and improving the overall efficiency of the claims process. For example, a smart contract could automatically process a claim and release payment to the policyholder once all the required information and documentation have been provided. This can speed up the claims process and reduce the risk of fraud or errors. Read more: Blockchain in health and life insurance.
Banking and Finance: Smart contracts can be used to automate financial transactions and reduce the need for intermediaries. For example, a smart contract could be used to execute a trade on a stock exchange, automatically transferring ownership of the stock and releasing payment once the trade has been executed. This can improve efficiency and reduce costs in the financial industry. Read more: Decentralized Finance: On Blockchain- and Smart Contract-Based Financial Markets.
Voting: Smart contracts can be used to conduct online voting in a secure and transparent way. For example, a smart contract could be used to ensure that every vote is counted and recorded accurately, and that the final results are tamper-proof. This can improve the transparency and security of the voting process. Read more: Improving End-to-End Verifiable Voting Systems with Blockchain Technologies.
Healthcare: Smart contracts can be used to securely store and share patient medical records, while also automating the process of claim submissions and reimbursements. For example, a smart contract could be used to automatically release payment to a healthcare provider once the service has been provided and the claim has been approved. This can improve efficiency and reduce costs in the healthcare industry. Read more: Blockchain: Opportunities for Health Care.
Energy: Smart contracts can be used to enable peer-to-peer energy trading, allowing individuals to buy and sell excess energy generated by renewable energy sources. For example, a smart contract could be used to automatically transfer ownership of energy units and release payment once the energy has been transferred. This can improve the efficiency and cost-effectiveness of the energy market. Read more: Blockchain in Energy and Sustainability.
Government: Smart contracts can be used to improve the transparency and efficiency of government services. For example, a smart contract could be used to automate the process of property registration, automatically transferring ownership and updating the land registry once the necessary documents have been provided and the fee has been paid. This can reduce the need for intermediaries and manual processes and improve the overall efficiency of government services. Read more: Guide to blockchain technology and its use in the public sector.
Gaming: Smart contracts can be used to create provably fair and transparent online gaming experiences. For example, a smart contract could be used to ensure that the outcome of a game is determined by a fair and transparent random number generator, and that the winnings are automatically distributed to the winner. This can improve the overall player experience and increase trust in the gaming platform.
Charity: Smart contracts can be used to ensure that donations are used for the intended purpose, by automatically releasing funds to the recipient charity once certain conditions have been met. For example, a smart contract could be used to ensure that a donation is only released to a charity once it has been verified that a specific project has been completed. This improves transparency and trust in the charitable giving process.
Music Industry: Smart contracts can be used to automate the process of music licensing and royalties distribution. For example, a smart contract could be used to automatically distribute royalties to the rights holders of a song every time it is played on streaming platforms. This can improve efficiency, reduce administrative costs, and increase transparency in the music industry. Read more: Music Copyright Management using Smart Contracts and Tokenization on the Ethereum Blockchain.
Manufacturing: Smart contracts can be used to automate the process of manufacturing, including the tracking and reporting of production data, and the distribution of payments. For example, a smart contract could be used to automatically release payment to a supplier once the goods have been delivered and accepted. This can improve the efficiency and transparency of the manufacturing process. Read more: Blockchain in the Manufacturing Industry — Key Use Cases.
Art and Collectibles: Smart contracts can be used to authenticate and track ownership of art and collectibles. For example, a smart contract could be used to automatically transfer ownership of a piece of art to a new owner once the purchase price has been paid. This can improve the efficiency and security of the art market.
Mobility Services - car-sharing, ride-sharing and ride-hailing: Smart contracts can be used to automate the process of car rental, leasing, and sales, including the tracking of vehicle usage and the distribution of payments. For example, a smart contract could be used to automatically release payment to a car rental company once a vehicle has been returned and the usage fee has been calculated. This can improve the efficiency and transparency of the car rental process. Read more: Blockchain for mobility services.
The Position of Regulators
The position of governments and regulators on smart contracts varies depending on the jurisdiction. In general, governments and regulators are still evaluating the potential benefits and risks of smart contracts and are working to develop a regulatory framework to govern their use.
Smart contracts aren’t always or necessarily legal contracts in the traditional sense, despite the word ‘contract’. Whether smart contracts are considered to be legal contracts is a question of whether the elements of a legal contract are present. If smart contracts are structured to automate actions, instructions or clauses of separate legal contracts but are not constitute legal contracts themselves then these non-legal contracts present fewer legal risks.
However, some smart contracts themselves could be structured as legal contracts and therefore have the full force of law. In such cases, it will be necessary to understand how they meet the pre-conditions for contract formation in different jurisdictions, as well as how they will be construed and interpreted by a court or arbitral body in the event of a dispute.
In some jurisdictions, smart contracts are not yet legally recognized as enforceable agreements, and there is uncertainty around the enforceability of smart contracts in the event of a dispute. Additionally, smart contracts must comply with the same laws and regulations that apply to traditional contracts, which can be a challenge.
Overall, the position of governments and regulators on smart contracts is still evolving, and it is likely that additional guidance and regulations will be issued in the future. It's important for organizations interested in using smart contracts to stay informed about the latest developments in their jurisdiction and comply with any applicable regulations.
Tools and Platforms for Creating and Deploying Smart Contracts
There are several tools and platforms available for writing and deploying smart contracts. Some of the most popular include:
Ethereum is a decentralized platform that enables the creation and deployment of smart contracts. It uses its own programming language, Solidity, to write smart contracts. Ethereum also provides a blockchain network on which these smart contracts can be executed. The Ethereum blockchain is the major building block for the alternative financial infrastructure of decentralized finance (DeFi).
Hyperledger Fabric is an open-source platform for creating and deploying enterprise-grade blockchain applications. It provides a modular architecture, allowing for flexibility in the design and deployment of smart contracts.
EOSIO is a blockchain platform for creating and deploying decentralized applications. It uses a consensus algorithm called Delegated Proof of Stake (DPoS) and provides a web assembly-based smart contract language.
Corda is a blockchain platform designed specifically for financial services. It uses a unique consensus mechanism called "notary" and allows for smart contract execution in a closed network of known participants.
Truffle is a development environment, testing framework, and asset pipeline for Ethereum-based smart contracts. It provides a suite of tools for creating, testing, and deploying smart contracts.
Remix is a rich toolset which can be used for contract development by users of any knowledge level, and as a learning lab for teaching and experimenting with Ethereum. It allows developers to write, test, and deploy smart contracts.
Embark is a framework for developing and deploying decentralized applications. It provides a suite of tools for creating and deploying smart contracts, as well as for building decentralized front-ends.
OpenZeppelin is a library for smart contract development. It provides a collection of reusable and secure smart contract code for a range of common use cases.
These are just a few examples of the many tools and platforms available for creating and deploying smart contracts. Each has its own set of features and capabilities, and the best choice will depend on the specific requirements of the project.
How to Get Involved as a Newbie
If you're new to the world of smart contracts and want to get involved, there are several steps you can take:
Learn the basics: Before diving into creating and deploying smart contracts, it's important to have a solid understanding of the basics of blockchain technology and how smart contracts work. There are many resources available online, such as articles, tutorials, and videos, that can help you learn the basics.
Choose a platform: There are several platforms available for creating and deploying smart contracts, such as Ethereum, Hyperledger Fabric, and EOSIO. Each platform has its own set of features and capabilities, so it's important to choose one that best fits your needs.
Learn a programming language: To create and deploy smart contracts, you'll need to know a programming language. Solidity is the most widely used language for Ethereum smart contracts, but there are other languages such as Vyper, the Binance Smart Chain's contract language, and Chaincode (Hyperledger Fabric)
Try a development environment: There are several development environments available that make it easy to create and deploy smart contracts, such as Truffle, Remix, and Embark. These environments provide a suite of tools that can help you get started quickly.
Join a community: Joining a community of other smart contract developers can be a great way to learn and get support as you're getting started. There are many online communities, such as forums and social media groups, where you can connect with other developers and share knowledge and resources. Examples:
Experiment with existing smart contracts: Start experimenting with existing smart contracts, by reading their code, testing them and understanding their use case and functionality. There are several places where you can find existing examples of smart contracts. Some of the most popular sources include:
It's important to keep in mind that smart contracts are only as secure as the code they are written in, so it's important to thoroughly review any smart contract code before using it for your own projects.
Participate in hackathons: Many organizations host hackathons and competitions focused on smart contract development, which can be a great opportunity to gain experience, learn from others, and build a portfolio of work. Here are a few examples of hackathons and competitions focused on smart contract development:
These are just a few examples of the many hackathons and competitions focused on smart contract development. Keep in mind that the frequency and number of hackathons may vary depending on the year, and hackathons usually have different theme and focus.
In conclusion, smart contracts are computer programs that can automatically execute the terms of a contract when certain conditions are met. They have the potential to revolutionize the way we conduct transactions and agreements by removing the need for intermediaries and increasing efficiency and transparency. However, like any new technology, smart contracts have faced criticism and opposition from various groups. Critics have cited complexity, lack of expertise, scalability, interoperability, legal and regulatory issues, immutability, limited functionality, privacy and confidentiality, smart contract languages, security, and performance as some of the main challenges facing the adoption of smart contracts.
The technical complexity of smart contracts lies in their design and development. Smart contract developers must have a good understanding of the blockchain technology they are working with, as well as the programming languages and tools used to build smart contracts. Additionally, smart contract developers must be familiar with the various security considerations and best practices for smart contract development. Scalability and performance issues are also important aspects that need to be considered during the design of smart contracts.
The technical complexity of smart contracts lies in their design and development. Smart contract developers must have a good understanding of the blockchain technology they are working with, as well as the programming languages and tools used to build smart contracts. Additionally, smart contract developers must be familiar with the various security considerations and best practices for smart contract development. Additionally, the scalability and performance issues are also important aspects that need to be considered during the design of smart contracts.