Because of the Blockchain technology application, many ordinary activities such as the contract of agreement and enforcement can be performed automatically by Smart Contracts. So what is Smart Contract? How does a smart contract work? All will be answered by GIG in this article.
What is Smart Contract?
Like traditional contracts, smart contracts are agreements between two or more parties where one party offers something of value to another, and the offer is accepted. The difference is that a smart contract is a self-executing code that carries out the terms of the agreement. This code is sent to an address on a blockchain as a transaction, where that blockchain’s consensus mechanism verifies it. Once this transaction is included in a block, the smart contract is initiated and irrevocable.
Smart contracts remove the need for intermediaries and contract enforcement. This greatly reduces cost and simplifies the contract negotiation process. With a smart contract, the code defines the transaction mechanisms and is the final arbiter of the terms. The immutability and irrevocability of the code in smart contracts is a strength but comes with drawbacks. For example, if there is a bug in the code, there is no way to invalidate or change the smart contract.
Smart contracts are autonomous, decentralized, and transparent. They are also irreversible and unmodifiable once deployed. This functionality has been utilized to make smart contracts the building blocks of hundreds of decentralized applications (dApps) and is a central focal point of blockchain development in general.
Why are smart contracts important?
Smart contracts allow developers to build a wide variety of decentralized apps and tokens. They’re used in everything from new financial tools to logistics and game experiences, and they’re stored on a blockchain like any other crypto transaction. Once a smart-contract app has been added to the blockchain, it generally can’t be reversed or changed (although there are some exceptions).
Smart-contract-powered apps are often referred to as “decentralized applications” or “dapps” – and they include decentralized finance (or DeFi) tech that aims to transform the banking industry. DeFi apps allow cryptocurrency holders to engage in complex financial transactions — saving, loans, insurance — without a bank or other financial institution taking a cut and from anywhere in the world.
So how would you use these smart contract-powered tools? Imagine you’re holding some Ethereum that you’d like to trade for USDC. You could put some Ethereum into Uniswap, which, via smart contract, can automatically find you the best exchange rate, make the trade, and send you your USDC. You could then put some of your USDC into Compound to lend to others and receive an algorithmically determined rate of interest — all without using a bank or other financial institution.
In traditional finance, swapping currencies is expensive and time-consuming. And it isn’t easy or secure for individuals to loan out their liquid assets to strangers on the other side of the world. But smart contracts make both of those scenarios and a wide variety of others possible.
How does a smart contract work?
A smart contract is a special kind of program that encodes business logic that runs on a special-purpose virtual machine baked into a blockchain or other type of distributed ledger.
Creating a smart contract starts with business teams working with developers to describe their requirements for the desired behavior of the smart contract in response to various events or circumstances. Simple events could be conditions such as payment authorized, shipment received, or a utility meter reading threshold. More sophisticated logic might encode more complex events such as calculating the value of a derivative financial instrument and processing trade of the derivative or automatically releasing an insurance payment in the event of a person’s death or a natural disaster.
The developers then work in a smart contract-writing platform to develop the logic and test it to ensure it works as intended. After the application is written, it is handed off to another team for a security review. This could be an internal expert or a firm that specializes in vetting smart contract security. Once the contract has been approved, it is deployed on an existing blockchain or distributed ledger infrastructure.
Once the smart contract is deployed, it is configured to listen to event updates from an “oracle,” which is essentially a cryptographically secured streaming data source. The smart contract executes once it receives the appropriate mix of events from one or more oracles.
Benefits of smart contracts
Speed, efficiency, and accuracy
Once a condition is met, the contract is executed immediately. Because smart contracts are digital and automated, there’s no paperwork to process and no time spent reconciling errors that often result from manually filling in documents.
Trust and transparency
Because there’s no third party involved and encrypted records of transactions are shared across participants, there’s no need to question whether information has been altered for personal benefit.
Blockchain transaction records are encrypted, which makes them very hard to hack. Moreover, because each form is connected to the previous and subsequent records on a distributed ledger, hackers would have to alter the entire chain to change a single form.
Smart contracts remove the need for intermediaries to handle transactions and, by extension, their associated time delays and fees.
Common issues and challenges with smart contracts
Some numerous issues and challenges need to be considered when planning a smart contract rollout:
Security: Smart contracts secure certain vital elements in a business process that involves multiple parties. However, the technology is new, and hackers continue to identify new attack surfaces that allow them to compromise the intent of the businesses that specified the rules. In the early days of Ethereum, smart contract hackers managed to steal $50 million in cryptocurrency. The IEEE has also documented concerns about inconsistencies in the tools used to detect different vulnerabilities in smart contract security.
Integrity: One oracle (one of the streaming data sources that send event updates) needs to protect against hackers faking events that trigger smart contracts into execution when they should not. It must be programmed to generate events, which can be challenging for complex scenarios accurately.
Alignment: Smart contracts can speed the execution of processes that span multiple parties regardless of whether they align with all parties’ intentions and understanding. But this capability can also magnify the impact of the damage that can occur when events spiral out of control, mainly when there is no way to stop or unwind unintended behavior. The Gartner research firm has noted that this issue poses challenges in smart contract scalability and manageability that have yet to be fully addressed.
Management: Smart contracts are complicated to implement and manage. They are often configured in ways that make them difficult or impossible to change. Although this could be considered a security advantage, the parties cannot change the smart contract agreement or incorporate new details without developing a new contract.
The future of smart contracts
Smart contracts are complex, and their potential goes beyond the simple transfer of assets. They can execute transactions in various fields, from legal processes to insurance premiums to crowdfunding agreements to financial derivatives. Smart contracts can disintermediate the legal and financial fields by simplifying and automating routine and repetitive processes for which people currently pay banks and lawyers sizable fees.
The role of lawyers could also shift in the future as smart contracts gain such capabilities as adjudications of traditional legal contracts and customizable smart contract templates. Additionally, smart contracts’ ability not only to automate processes but also to control behavior and their potential for real-time auditing and risk assessments can be beneficial for compliance.
Smart contracts also show promise in automating processes that run on IoT and edge computing devices. For example, a utility company might offer a service in which smart contracts execute in response to changes in power rates in coordination with devices built into power meters. For example, when prices reach a given threshold, a smart contract might automatically turn off or turn down power-hungry appliances such as air conditioners using a specially controlled IoT controller.
Another potential use case is integrating smart contracts into vending machines to release goods in response to cryptocurrency payments.
Above is information related to the term “Smart contract,” which has impacted society. Hope the article “What is a Smart Contract? How does smart contract work?” is helpful to investors. Subscribe to GIG Dollar to stay updated with the latest news on blockchain, cryptocurrency, digital asset investment, etc.
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