What Are Smart Contracts?

Smart contracts are digital versions of what closely compares to legal agreements in our daily lives. They are stored on the blockchain as coded agreements between parties with clearly defined terms, outcomes, and consequences. They are self-executing contracts on the blockchain that have deterministic outcomes and follow an "if-then" semantics.

For example, if party A or B fulfills a requirement X, then do Y, otherwise do nothing, or do Z. Smart contracts rely on the information available on the blockchain or on data provided by oracles such as Chainlink to retrieve dynamic data from the real world. The reliability of external information raises questions about the reliability of smart contracts, but the oracle services are, themselves, decentralized and driven by incentives.

Summary of Important Points

  • Smart contracts are digitized, decentralized, and trustless versions of everyday contracts or agreements between people, known as parties.
  • They follow an if-then procedure, self-executing the terms of the contracts as soon as the condition is fulfilled.
  • Smart contracts exist on the blockchain, and so they sometimes rely on oracles to relay data from the real world.
  • Oracles are decentralized, so even though they act as a trust layer for smart contracts, they still maintain the decentralized nature of smart contracts.
  • Smart contracts are automated and start executing as soon as the terms of the contract are fulfilled.
  • Anonymity of the parties to the contracts is guaranteed.
  • All smart contracts are visible and accessible to everyone on the blockchain where they are written and stored.
  • Smart contracts can be used to automate everyday contracts, build decentralized applications, create DAOs, store data, and issue tokens on the blockchain.

How Smart Contracts Work

Smart contracts are written in programming languages defined by the blockchain where they exist. They work with the instructions stored by the creator but must be consistent before being deployed successfully. Smart contracts can also interact with other smart contracts and oracles in their workings.

They can serve various purposes that require two or more parties, such as storage of data, minting of NFTs and graphics, and creation of decentralized applications, stablecoins, automated insurance and reinsurance, and customized tokens.

Features of Smart Contracts

Completely Automated The parties to the contract only need to fulfill the requirements for the smart contracts to execute. A third party required by traditional contracts, such as the judge or arbitrator, is not needed for smart contract settlements. Fundraisers can start pulling funds together and set their max limit to a certain amount, after which the funds are transferred to the account of a charity.

Defined and Predictable No two judges interpret the same contract in the same way, costing parties billions of dollars and causing irreparable pain. The unreliability of traditional institutions leads to distrust and sometimes unending quests for redress. Smart contracts need no appeal as they are automatically executed based on the exact written conditions in the agreement. This allows anyone to review the smart contract before signing or interacting with it, helping to prevent further fraudulent transactions, especially in cases where malicious actors wrote the contracts.

Public The data is stored on public ledgers like the Ethereum blockchain, where anyone can access the contracts and see the preconditions and results. All parties to the agreements are aware and can trace every bit of the transaction on the blockchain.

Anonymous Blockchains are built for privacy, so no one can be implicated by having their names written, as in traditional contracts, especially in transactions involving vast sums of money. Your identity is always protected from everyone since only addresses are visible on explorers.

Benefits of Smart Contracts

  • The blockchain secures smart contracts, which are more mathematically precise than humans.
  • Smart contracts can store product data for tracking in the pharmaceutical and real-estate industry.
  • Storing healthcare data on the blockchain using smart contracts can prevent personally identifiable information and patient data breaches.
  • Smart contracts can make elections simple yes or no processes free from hacking or double-counting.
  • Smart contracts can prevent fraud in insurance claims and identity verification.

Risks of Smart Contracts

  • Smart contracts storing huge amounts of money are often targeted by hackers who exploit errors in the code instead of breaking the code. Developers are humans and often make mistakes.
  • Dishonest creators of smart contracts can wait for others to join in and sell off on unsuspecting participants, leading to a rug pull.
  • Traditional institutions and everyday users of traditional legal contracts are suspicious of smart contracts.
  • Smart contracts cannot be changed once they are deployed to the blockchain, increasing the precision requirements for effective development to an almost impossible level.
  • Regulating smart contracts still results in some level of confusion and uncertainty as traditional legal setups need time to catch up to this advanced system.
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