Smart Contract: What it is and How it Works

One of the most recent advances in the crypto world has been the possibility of implementing programs that run on a blockchain. These programs are known as “smart contracts” and can execute transactions automatically, without intermediation, within the blockchain if the required conditions are met.

Smart contracts are accounts of the blockchain. They have balance and can send transactions on the network. However, unlike externally owned accounts, which are controlled by individuals who hold the private keys, smart contracts are deployed on the blockchain for self-executing transactions.

In addition, smart contracts can call other smart contracts and even deploy new contracts, enabling the creation of complex and intricate algorithms on the network.

The consequences of this can already be seen today with the development of decentralized autonomous organizations (DAOs) running mainly through smart contracts and decentralized exchanges like PancakeSwap and UniSwap.

In fact, smart contracts are present all over the crypto world. When an NFT is sold on the Empire NFT Marketplace, for example, there is not an individual who transfers it from the seller’s account to the buyer’s. The entire process is performed automatically via smart contracts, ensuring the proper transaction of the NFT is done securely and instantaneously.

History and Technology of Smart Contracts

The term “smart contract” was first coined by the American lawyer, computer scientist, and cryptographer Nick Szabo in his papers published in the 1990s. One of his main intents with this new concept was to design electronic commerce protocols between untrusted parties.

Nick Szabo was also the designer of “bit gold,” the first attempt to create a decentralized digital currency that would act similarly to gold as early as 1998. However, bit gold was never implemented. Still, it is considered by many to be the precursor of Bitcoin.

Nick Szabo’s large presence in the cryptography-based financial sciences business has led to speculation about him being Satoshi Nakamoto, the creator of Bitcoin. However, in 2014, Szabo vehemently denied that he had actually created Bitcoin.

One of the most widely used examples of a proto-smart contract is vending machines. These machines work autonomously, self-executing functions to deliver an output according to the input.

A simple function could be: if the input is $1 and the chosen item is worth $1, then deliver the item; if the item costs more than $1, then don’t deliver the item and return $1; if the item costs less than $1, then deliver the item plus change.

In the year 2014, the Ethereum whitepaper was the first to mention the use of smart contracts on a blockchain. According to its founders, blockchain technology should take a step forward to deliver possibilities beyond just performing transactions between users.

It was then decided to implement a new type of account that runs functions and data on the Ethereum network. This account, like any other, has an address on the blockchain.

Smart contracts can be deployed on the network by anyone. The only prerequisite is knowing how to code in a smart contract language, such as Solidity or Vyper, and paying a deploying tax.

However, there are some intrinsic limitations to smart contracts. Among them is that such code has no direct access to physical data, requiring an oracle to provide reliable data about the physical world.

Another limitation is the maximum contract size. In general, most blockchains that support smart contracts limit their sizes to 24KB. Thus, to create more complex smart contracts, it is necessary to use methods like Diamond Pattern, which calls external functions supplied by contracts called facets.

Some Applications of Smart Contracts

The applicability of smart contracts goes beyond imagination. Smart contracts take blockchain technology to a whole new level, and this is not just limited to transactions.

There are many industries and sectors of society that can benefit from the wonders that smart contracts unleash. From finance to countries with fragile democracies, the possibilities are immense.

In trade finance, smart contracts can save more than $20 billion a year. This is because a lot of the time and human resources used for approving workflows and clearing calculations are now automated by smart contracts.

This revamp is dramatically increasing the efficiency of many institutions around the world and, at the same time, drastically reducing the chance of errors, fraud, and mistakes.

In addition, smart contracts can be used to validate votes in fragile democracies where fraud by traditional voting systems is most likely to occur. Blockchain technology, by recording information in an encrypted, secure, tamper-proof, and quickly accessible form, can be used as the foundation of a voting system that guarantees true democracy.

Conclusion

Smart contracts are a relatively new technology that allow transactions to be executed without the intervention of a third-party, in a secure, automatic and immutable way.

Since its first implementation into the blockchain technology in 2015, hundreds of ideas and solutions to real problems have been developed based on this concept.

This is all quite new and has already proven to be very useful. In fact, the adoption and entry into this new ocean of crypto solutions has just begun. So far, we have only scratched the surface of what this technology will allow us to do.

Even for issues inherent in blockchain technology itself and its limitations, ingenious new solutions are appearing every day, pushing the frontier of possibilities further than ever imagined.