What are smart contracts?

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09.11.2021 06:29
What are smart contracts?

    In the real world, a contract is an agreement between two or more parties. These contracts contain certain conditions, the fulfillment of which is for all or part of the participants. Contracts have been known for quite some time. Today, no deal is carried out without its terms being reflected on paper or electronically.

    The problem with contracts in the real world is that they can only be drafted by lawyers, taking into account all the features of the legislation. Naturally, such contracts use specialized vocabulary that is used in jurisprudence. It is often difficult for an ordinary person to understand the pitfalls in such agreements. Therefore, performance of contracts sometimes does not go the way the parties expect.

    This is why some scientists and programmers have been involved for quite some time in the automation of contracts and making it possible to draft them with a minimum set of terms that would not baffle the average user.

    The first person to describe smart contracts was Nick Szabo. Back in the 90's he gave his definition of such electronic contracts. In addition, Szabo roughly described the areas in which such electronic contracts could be applied. He accurately pointed out that they would be great for copyright protection or in the lending industry.

    In modern terms, a smart contract is simply an application that runs on one of the blockchains (the most famous in this regard is Ethereum). It is an agreement in digital form. Unlike contracts, which have long been digitally signed, such contracts are on distributed networks. This means that once they are published and sent to the blockchain, no one can modify or tamper with them.

    What is a smart contract in simple terms? It’s a contract on the blockchain, these are contracts on the blockchain, the implementation of which is not verified by a person, but by a distributed ledger. That is, the parties assume certain obligations under an agreement, and they do not have to trust each other at all. If one of the counterparties violates the terms of the document, it will not work and the other clauses will not be fulfilled.

     

    Here's a simple example. Let's say a person buys some product from an online store. The smart contract could specify the following:

    1. Sell the product to the customer at X price (X in this case is the cost on certain days).
    2. Ship the products on X day (this condition is stipulated on the online store's website).
    3. Deliver the goods.
    4. Funds are credited only after acceptance by the buyer.

    All conditions of this smart contract must be fulfilled. Only in this case the program will unfreeze the tokens that were blocked during the checkout and the launch of the smart contract.

     

    Smart Contracts: the beginning

    Although the concept of smart contracts was described quite a long time ago, it only became a reality with the advent of blockchain. After all, it is an environment where you can count on independent verification of conditions and their fulfillment. Outside a distributed ledger, such contracts are nothing more than software code that no one will trust.

    An important condition in the operation of any smart contract is Turing completeness In the Ethereum blockchain, this is implemented by Solidity, the Turing complete language. It makes possible the development of more complex applications. However, there is one problem: such contracts are more difficult to verify in terms of vulnerabilities.

     

    Features of smart contracts

    These electronic contracts have a number of characteristics or features that distinguish them from standard contracts known outside of blockchain.

    Decentralization

    Smart contracts have a distributed nature. They are dispersed among different nodes in the blockchain. Accordingly, they cannot be tampered with or deleted. If you imagine an ordinary contract in a computer, for example, you can take it out, change the information in it, and add it back in again. This will not work with a smart contract. It is added by the nodes of the blockchain once.

    Specific goals

    Every smart contract is created with one purpose: to control the fulfillment of its conditions. After that, it is executed and that is the end of its work. The result of such a digital contract will be the same, regardless of who fulfills the requirements laid down in it.

    No need to do everything manually

    With the help of smart contracts, it is possible to automate some processes. For example, if you apply it in a cryptocurrency exchanger and prescribe the conditions under which the transaction is considered completed, all actions will be controlled by the program. It will unblock the tokens that are frozen under the terms of the contract. In this case, the presence of an employee who would check the transaction itself is not required.

    Information in the document cannot be changed

    This feature is unique to those contracts that are implemented on the basis of the blockchain. They are sent to the network and added by nodes. After that, no one can change the terms of such contracts. So, in case the contract turns out to be wrong, you will have to leave it as it is and create a new one which will take into account all the shortcomings.

    Flexible customization

    Smart contracts are not a standard set of code. They can be customized for any conditions and actions. This is the reason why such contracts are predicted to have a great future. They can be used literally in any area of human activity.

    Trust between the parties

    Ordinary contracts are usually overloaded with information about what kind of responsibility the parties bear in the event of the occurrence of certain conditions. This is done in order to be able to subsequently resolve issues in pre-trial or judicial proceedings. Everything is simpler in smart contracts.  Trust is established by the fact that neither party can influence the implementation of a smart contract, since it is located in an independent blockchain. As a result, many terms and conditions do not need to be negotiated and reservations do not need to be made. If one of the parties fails to fulfill its obligations, the smart contract will not be enforced.

    Transparency

    Finally, all blockchain-based contracts are considered transparent. The fact is that the source code of each contract is available here, and the parties can make sure that there are no pitfalls in the agreement.

    Smart contracts and their application

    So, a smart contract is an ordinary program. But once it gets into the blockchain, it becomes a fairly effective tool, which allows not only to control the terms of the agreement, but also to do without a number of intermediaries.

    The code used to write such a digital agreement cannot be changed. It can be viewed, because it is usually in the public domain. It can be copied and changed on your own server. But that will not affect the execution of the original smart contract!

    A smart contract can replace not only some intermediaries, but even the management of an entire decentralized organization, as well as some government services. That is why the attitude to blockchain in some countries is rather cautious.

    For comparison, any existing payment system, such as Webmoney, can be cited. The administration is in charge here. It is the administration that solves disputes, maintains the system, and is responsible for transactions.

    In a decentralized system, all this will be different. Here everything is subject to the rules established in the smart contract. That is, conventionally, every user can take part in the work of such organizations, if he meets certain conditions (for example, staking a certain number of tokens).

    Potential uses of smart contracts

    First of all, such an approach can be implemented in the system of financial relationships. For example, when paying for goods or services, bank-to-bank transactions, and so on. Nowadays, any non-cash transactions require a certain set of approvals. This not only complicates the entire process, but also makes it slower.

    Such transactions are also costly. According to recent research, the implementation of blockchain technology will save more than $20 billion annually. This will reduce the burden on users, as bank customers are the ones who bear the burden of such costs.

    The social and political spheres are potential customers of blockchain networks. For example, any kind of voting, including parliamentary or head of state elections, can be organized on the basis of a distributed ledger

    In this approach, each citizen will be issued a token with which to vote. The results will be counted by means of a smart contract. That is, none of the candidates will be able to manipulate them.

    But there is one problem. This approach is only possible in states with a multi-party system, where no one has the ability to put pressure on the electoral authorities. Otherwise, the smart contract can be written in such a way that the results will be known in advance. And it will only be a cover for dishonest voting.

    Smart contracts can also be used in various social projects. For example, when conducting independent surveys. The approach is much the same here. In the process of voting. Users will transfer tokens to a specific (or multiple) smart contract.

    Such blockchain-based digital contracts can also be applied to logistics. Today, these are complex processes that require a mass of approvals and payments. Moreover, the participants in the entire supply chain do not always have access to the documents. They have to be sent in paper form. All this significantly complicates the procedure, making it more time-consuming and too costly.

    With smart contracts and blockchain, it is possible to ensure that information at every stage enters a distributed network and that each participant has access to it without the need to send physical documents. Moreover, this approach would increase the level of trust, for example, in the origin of goods.

    Payments in logistics will be distributed automatically after each stage of delivery. This will also avoid unnecessary turnover of documents. Moreover, with this approach, any logistics scheme can be scaled by easily adding new participants to it.

    IoT (Internet of Things)

    This is a fairly popular trend today. In the future, electronics are expected to interact more with the Internet. The transfer of many functions to blockchain with smart contracts would make all processes more transparent. For example, when charging an electric car, the car itself could pay for this service.

    In addition, users would be able to record the rights of ownership for certain gadgets in blockchain. At the same time, no one will be able to change or forge them. It will be possible to check it using any gadget connected to the Internet.

    Delivery

    This is a good way to improve the online shopping system. Buyers incur large costs related to payment. If you add smart contracts to this scheme this will eliminate unnecessary costs and intermediaries. As soon as a parcel is delivered to the recipient, an automatic calculation is made.

    In this case, another problem associated with the work of online stores will be avoided - prepayment. Everyone is familiar with situations where goods arrive in poor quality with significant defects. Money has already been paid, and the buyer has to waste time arguing with the store. In the case of smart contracts, the client of the store will first verify the quality of the product and only then will the payment be made.

    In addition to the above, additional conditions can be added to smart contracts, which imply a certain delivery time or storage time of the parcel.

    Betting on sports

    This is one of the most obvious uses of smart contracts. Bets are entered into a blockchain. When the game is over, the prizes are distributed according to the terms of the smart contract between the winners. The advantage of using blockchain in this case is that no one can manipulate the results or cheat on the payout. In addition, just one smart contract can replace an entire bookmaker's office, which means that gamblers won't have to deal with intermediaries.

    Legacy

    Smart contracts can be used in inheritance distribution. While in today's economy this is handled by lawyers, with the introduction of smart contracts, all functions can be transferred to the blockchain. Once a will comes into force, money as well as other valuables will be transferred according to the terms. Such documents will not need to be notarized, as they go into the blockchain, the environment of shared trust.

    Real estate transactions

    Smart contracts can be applied to the real estate industry as well. For example, they are ideal for rental deals. With a smart contract, the data about the object is put on the blockchain with the stipulation that when money is transferred to the account, the landlord gives the keys to the tenant. This is ideal for a smart city or smart home where the lock can be connected to the Internet. If the tenant doesn't transfer the money at the beginning of the month, the lock is blocked.

    Health care system

    The use of smart contracts in healthcare is possible in a variety of industries. For example, a distributed ledger can be applied to store medical records. In addition, scientific research in the field of medicine can be published on the blockchain.

    Media

    In the media, smart contracts are useful to make payments and distribute money transparently in the system.

     

     

    Challenges of implementing smart contracts

    While smart contracts have great promise, there are some challenges associated with their future implementation.

    External Agents

    While smart contracts solve many problems and issues, they cannot determine which information is valid and which is not. Accordingly, oracles are needed that are responsible for validating the data.

    Blockchain allows you to keep information unchanged. When it is received from the outside world it will require someone to verify the incoming data. This can be a lawyer, scientist, doctor, real estate professional and so on. Accordingly, it will not be possible to remove intermediaries from any chain completely.

    Indeed, with the help of a smart contract, it is possible to automate all or part of some processes. However, in order to make it work in the real world, it is not enough to create this program. It is important that each smart contract is verified before it is added to the blockchain.

    Legal issues

    In order for smart contracts to be used in any sphere, a new environment needs to be created that can integrate the blockchain. Today, such digital documents have no legal force. If you create a smart contract in the real estate industry, for example, it would not have the same validity as an ordinary contract between a buyer and seller or a tenant and a landlord. It will take a long time before blockchain can become an integral part of the real economy.

    Distrust of the distributed ledger

    Although blockchain technology has been open to the public for more than 10 years, it is still young and ‘immature’. There are many problems that are being solved by developers, but some issues are being replaced by others. All of this fully applies to smart contracts. In terms of technology, digital documents certainly represent a breakthrough and have tremendous promise. But in the current situation, their widespread application is complicated by the fact that there are a lot of unresolved problems.

    In addition, not all companies are confident that the transition to blockchain and smart contracts will save them money or increase speed. This lack of confidence also significantly slows down implementation.

    Blockchains where smart contracts can be created

    Smart contracts are known to be created on the Ethereum platform. This blockchain appeared in 2015. Since its launch, 1,000 of these applications have been implemented on the platform, including the infamous DAO (decentralized organization). Despite its failure as a result of token theft from a smart contract, the idea itself opens up new possibilities for using blockchain.

    One of Ethereum's strongest contenders is Hyperledger Fabric. The platform was launched around the same time as Ethereum. One of the advantages of using this particular blockchain is that the smart contracts here have a higher degree of security. This distributed ledger may not be as well-known among individual users. However, in the corporate environment, it has clear leadership.

    Another blockchain on which smart contracts can be implemented is Stellar. It differs in that it offers a simpler interface for creating apps. Although, at the moment, the popularity of this network is lower than that of Ethereum and Hyperledger. Stellar is mostly used to conduct ICOs or create smart contracts.

    NEO is considered the Chinese Ethereum. It is a much faster blockchain with up to 10,000 transactions per second. In Ethereum, by comparison, on average you can carry out about 30 transactions at the same time. The development of the project is supported by the well-known technology company IBM, as well as the government of the Celestial Empire.

    Finally, smart contracts can be created in the new Free TON blockchain. It comes on the heels of the TON blockchain team stopping further work on the project. It is currently one of the fastest networks with 100,000 transactions per second. Smart contracts can be written on the network in a variety of programming languages. That is why many developers come to TON.

     

    Pros of smart contracts

    The main advantages of smart contracts include:

    1. Automation of processes. With the help of these contracts, it is possible to conclude various transactions without the participation of a chain of intermediaries. Execution of such contracts is carried out automatically when certain conditions are met and does not require any action exactly with the contract on the part of the counterparties.
    2. High level of trust. All information is stored in a distributed ledger. No one can make any changes to a smart contract or tamper with it. All this allows parties of transaction to be sure that execution is possible only if pre-determined conditions are met.
    3. Less bureaucracy and paperwork. Less ‘paperwork’ is required when working with smart contracts. This saves a lot of time.
    4. Secure storage. Smart contracts are duplicated in blockchain, which eliminates the loss of information.
    5. Cryptographic encryption. Used in the blockchain, accordingly all transactions and operations in the network have a high level of security. It is extremely difficult to hack into such applications or steal money.
    6. Saving money. Since the use of smart contracts eliminates some intermediaries, when working with blockchain it will be possible to reduce the cost of lawyers or commissions of various services.
    7. No human factor. Smart contracts clearly spell out the terms under which they are executed. A person can make mistakes in the process of providing goods or services. A smart contract executes the code in it. If there are no errors in the code or the terms of the contract, then it will be executed without errors.

    Cons

    Despite the promise of these smart contracts, they are far from perfect. For example, it is still unknown how taxes will be deducted, as well as how exactly such applications will be regulated by government services. In addition, despite the absence of a human factor in the execution of a contract, it may be present in the programming of the app.

    What happens if there is a mistake in a smart contract? In the case of a paper document, the terms can be challenged through the courts. But what if it is a smart contract on a blockchain? It will be enforced according to what the terms are in the app, which may lead to a lot of problems in the future.

    Smart contracts are a big step toward reshaping society and economic relationships. That is why many people are keeping a close eye on the development of blockchain technology. 

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