Mall investors have come to accept that cryptocurrencies have a place in many portfolios. However, some do not understand the functions of cryptocurrencies beyond their use as a digital asset and digital currency.
One of the most important crypto functions is smart contracts, which can be difficult to understand. Understanding smart contracts could make a difference in what cryptocurrencies you buy and how you use them.
“As the world pivots to a more digital world, smart contracts are something to be better understood,” said Anouk Brumfield, senior executive at IBM. “Smart contracts are not paper contracts, but, in essence, the set of rules that all parties agree on; it is software stored and executed on a blockchain. Blockchain, in simple terms, is a distributed ledger that promotes trust and transparency. »
What are smart contracts?
The Ethereum blockchain was the first to house smart contracts, which some say are one of the most useful applications of blockchain technology. Smart contracts execute themselves, automating various business applications when running on a decentralized blockchain. However, they only run if certain conditions are met.
Since smart contracts require a decentralized network, they remove the need for an intermediary in transactions. For example, a conventional contract obliges a court to intervene if one of the parties violates the terms of the contract.
However, all consequences of breaching smart contracts occur automatically without the need for an intermediary to enforce them. They set the terms of the contract in computer code, allowing automatic execution when certain conditions are met.
Smart contracts are basically programs stored on a blockchain. They can also be used to automate workflow by triggering action once a set of conditions is met. Smart contracts can perhaps best be described as business rules written in computer code using if/then language.
For a more technical definition, we can turn to the US National Institute of Standards and Technology. He describes them as a “collection of code and data (sometimes called functions and state) that is deployed using cryptographically signed transactions on the blockchain network.”
Although Ethereum was the first blockchain to be designed with smart contracts in mind, they are not limited to Ethereum or any other particular blockchain or decentralized network.
The history of smart contracts
According to CoinDesk, the concept of a smart contract dates back to 1993 when cryptographer and computer scientist Nick Szabo described it as a kind of digital vending machine. The original Ethereum blockchain whitepaper described the Bitcoin network as supporting very basic smart contracts.
Every transaction made on the Bitcoin blockchain is essentially a smart contract because the network only approves the transaction after specific conditions are met. In the case of Bitcoin, the user produces a digital signature that proves they own that particular token.
When Ethereum arrived, smart contracts became much more complicated than transactions on the Bitcoin blockchain. The Ethereum blockchain allows developers to create smart contracts capable of a wide variety of different automated actions. Once a developer has coded a smart contract, anyone with access to the protocol can use it.
Applications of smart contracts
Despite their name, smart contracts do not necessarily constitute a binding legal agreement between two or more parties. Instead, they provide a way to automate the execution of certain obligations that must occur after another action has been taken. Some examples of smart contract protocols in use today are Ethereum apps MakerDAO and Compound, which use smart contracts to lend and earn interest.
Due to the wide range of potential smart contract applications on the Ethereum blockchain, developers can create smart contracts that do almost anything they want. Some common apps include multi-signature accounts, which only allow account funds to be spent when a set percentage of people agree.
Smart contracts can also be created to manage and automate agreements between users. For example, the developer can set a certain action to occur if or when a user wants to trade something. Smart contracts can also be developed to extract data from the outside world using oracles, which extract data from the outside world into the blockchain to be used for the smart contract.
Smart contracts can be created to work with other smart contracts or even for something as basic as storing information about an application like membership records or domain registration information. Storing data on a blockchain means it can never be erased or altered.
Smart contracts can also be used to store someone’s digital identity, manage a supply chain, perform financial transactions, automate mortgages, automate government operations, and more. One of the most promising areas for smart contracts is the financial sector, where they can have many applications.
Advantages and disadvantages of smart contracts
As with everything, there are pros and cons to smart contracts. Perhaps the most obvious is that they are automatic because they automatically trigger actions when certain conditions are met. This allows businesses or governments to operate more efficiently and creates trust between parties where they might otherwise not trust each other.
Smart contracts are also secure because they are encrypted and cannot be changed, which means that all data stored in a smart contract on a blockchain cannot be changed. They make automation and trading more profitable by cutting out middlemen, and they allow actions to be executed much faster than other methods. If the developer codes the smart contract correctly, it will always be accurate and error-free. Brumfield added transparency, reliability, and security as additional benefits.
On the other hand, the fact that they cannot be modified can cause problems for various reasons, such as if there is an error in the code. Also, like conventional contracts, there can always be loopholes, and developers could make a mistake while creating them, causing them to have vulnerabilities or bugs. Hackers could find ways to exploit a bug in some smart contracts, allowing them to steal millions of dollars worth of cryptocurrency.
Finally, due to the novelty of smart contract technology, the legal regulation for their application is weak. Also, some people might not trust smart contracts because they don’t understand the technology. According to Brumfield, some additional downsides include lack of flexibility to make changes, challenges in managing complexities, and lack of mass adoption and scalability.
“Essentially, smart contracts speed up processes, increase security, reduce costs while providing transparency,” Brumfield concluded. “As adoption increases, we may see other advantages and/or disadvantages.”
No one knows if smart contracts will become an integral part of everyday life. We are still in the infancy of this technology, so it is impossible to know if they have a future.
However, the potential applications of smart contracts are virtually endless, so betting on the technology by investing in it isn’t necessarily a bad decision, even if it’s purely speculative at the moment.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.