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What is a “smart contract” and what is it actually used for?

Education

6 min read

As you know, Ethereum has largely opened up and democratized blockchain, and that's how we started hearing about the famous "smart contracts"... Sometimes, without really understanding the issues behind them or even fully grasping the impact they can have on DeFi...

Although smart contracts were popularized (and widely used) with Ethereum, it turns out that the concept itself emerged quite some time ago. In fact, the first time it was really discussed dates back to 1994 with a publication by Nick Szabo , a notorious cypherpunk.

He is a pioneering computer scientist in the field of online digital payments. He collaborated with David Chaum , inventor of the electronic money "E-Cash" in the 90s.

That said, it was really only with Vitalik Buterin and his white paper that smart contracts became a reality. And, in particular, thanks to the possibility of associating them with cryptocurrencies.

This is why Ethereum isn't the only protocol used for programming smart contracts. Smart contracts can be deployed on other blockchains. That said, due to its popularity and ease of implementation, Ethereum is the platform on which the most smart contracts have been created.

Definition of a smart contract

To best define smart contracts, remember that they are computer programs that cannot be modified once they have been executed. This is precisely because they are deployed on a blockchain. They then follow a set of predefined rules to be able to execute automatically.

Thus, in the real world, a contract is executed through a third party, such as a lawyer. This is how contracts are defined. Validation is, in fact, carried out by a third-party legal institution. However, on the blockchain, this third-party institution no longer has a role in validating the contract. It can be executed automatically, through the power of computer code. This is why Lawrence Lessing 's expression "code is law" has been adopted in this context. The expression has become famous because it perfectly summarizes the situation. It is indeed a kind of equivalent to a notarized contract, for example, but in digital form.

This is precisely what smart contracts are for: executing a real-life contract on the blockchain for real-life use. Hmm…? Am I clear…?

See the illustration below:

This is an illustration created by Bitpanda

To put it simply, a contract will operate according to a defined causality. If "x" happens then "y" will happen. As they say in mathematics, "if this, then that". For example, if a person gives x on the blockchain, then they will receive y.

A smart contract is a digital contract, which is self-executing according to predefined rules. It can send, validate or implement the execution of an agreement between two (or more) parties. It is stored on a decentralized blockchain.

This is the simplified version of smart contracts. Many smart contracts are more complex. Indeed, there are no limits except human imagination. Entrepreneurs have very strong ambitions, and we are already seeing smart contracts applied to relatively complex systems. If a smart contract contains a whole host of legal rules, generally, we tend to turn to DAOs ( Decentralized Autonomous Organizations ). These are indeed better suited to everything related to governance in general.

DAOs are another, equally interesting and useful pillar of Ethereum. There are more and more projects in this area. For the moment, this still remains in the experimental phase for most DAOs.

We will come back to this in a dedicated article.

How does a smart contract actually work?

Normally, with the definition you should understand (at least slightly) how it works. Unlike the execution of a traditional contract, all contract validation steps are recorded on the blockchain. This is how all operations are secure and visible to everyone. We cannot therefore modify, change, delete or censor an operation. (And this is specific to blockchain, and not necessarily to smart contracts).

This allows us to implement smart contracts in various fields where they have real applications. For example, we saw with the startup RealT that smart contracts enabled the purchase of real estate on the blockchain. Everything is automated. The purchase and resale are recorded, and therefore no one can censor or modify this information. Indeed, everyone can verify the proper execution of a contract on the blockchain and even know who owns a particular asset. Can you imagine how useful this could be, for example, with land registry records?

The fact that this is based on computer code allows us to avoid the problems associated with human manual tasks. These are subject to errors, misinterpretations and a certain slowness…

Most smart contracts follow standards, and the best-known and most widely used is ERC -20. Indeed, ERC-20 is the most prevalent smart contract. This explains why the vast majority of tokens are ERC-20 tokens. This type of smart contract allows for the creation of tokens on the Ethereum network.

It is especially with this standard that we also realized that Ethereum could change our lives or at least improve entire sectors of our economy.

Now let's see what the advantages of the smart contract are

✅ Ease

One of the biggest advantages of smart contracts is how easy they can be created today. On the Ethereum network, for example, using the Solidity programming language, smart contracts can be created relatively easily. There are a kind of computer "template" (standards like ERC-20) that allow for the easy creation of smart contracts.

✅ Safety

The other big advantage of smart contracts is that they are secure on the blockchain. Unlike traditional contracts, no one can falsify them. In fact, there may be ways to modify data on the blockchain but technically this would mean having more than 51% of the power of the network. Which is, in reality, hardly possible.

✅ Reliability

A smart contract will automatically execute on the network. We can then secure an agreement between two parties. With transparency and immutability, we can be sure that both parties have what they agree on. No possible errors or corruption as is unfortunately very often the case today.

✅ Speed

The fact of not having an intermediary, or even a human one, makes the execution of contracts extremely rapid. No more need for a notary or lawyer to specify a contract or validate it, it is the smart contract which will do this systematically.

What are the disadvantages of smart contracts?

There can't be only advantages, you tell me!

That said, the advantages are so enormous and bring so much efficiency to our systems, that the disadvantages seem small in comparison.

In fact, the biggest disadvantage is that there may be flaws in the computer program. We saw in the article which explains what Ethereum is, that a big hack was precisely at the origin of the division in the original Ethereum Classic (ETC) blockchain.

Beyond the purely technical flaw, it turns out that sometimes, for certain projects or sectors, human presence proves useful, if not essential. Sometimes human governance is needed not to validate smart contracts but rather to judge them in the event of a unique situation.

To this question, the solution seems to be provided with DAOs, and it is still a subject on which many people are working.

That said, there are still clans. Some do not want the slightest human intrusion into the blockchain while others find it necessary and useful at times.

Final word on smart contracts

In fact, smart contracts are still at an embryonic level but have a very bright and bright future, that's for sure. Numerous decentralized applications in the medical and insurance sectors, and especially in the supply chain (pharmacy, agro-food, cosmetics, medical and food, etc.) are under development.

Most certainly, in future years you will see more and more blockchain projects appearing. We are excited! Our current use of paper contracts will shift to digital for greater efficiency in our businesses. Overall, it is the individual who will benefit because it will facilitate their work in a profound way. Ultimately, that’s what we all aspire to…

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