Smart Contracts - what they are?

By
Tokeneo
-
5 min reading

Smart contracts are another step in the development of blockchain technology. It consists in moving from a traditional financial transaction protocol to a universal tool that will fully automatically implement the terms of the contracts. This minimizes the risk of error or manipulation. Contracts provided in this way ensure simplicity, speed of execution and real-time data update. In this aspect, standard methods have no chance of smart contracts. Moreover, their use excludes the need for intermediaries and various types of central institutions through which the contract must pass. But what exactly are smart contracts? You will learn this from this article!

smart contracts

What are smart contracts?

It's a kind of very simple code, which is one of the elements in networks such as: Ethereum, NEO, ARDOR, LISK, EOS, CARDANO. They are based on IFTT (if this, then that). In other words, a smart contract is perceived by the network as an ordinary user, i.e. in practice it can send and receive transactions because it has its own portfolio address. He can also read the data contained in the blockchain himself. The most important thing, however, is that the data placed in the form of a smart contract cannot be removed or modified. Smart contracts are transactions that can be used in many areas of everyday life, for example:

  • auctions
  • elections
  • escrow contracts
  • purchase and sale contracts

Smart contracts work basically like regular contracts. The parties agree among themselves on specific conditions that can be reduced to a scheme: if X happens, follow Y). Then the terms of the contract are saved - however, in this case not in paper form, but in a blockchain application.

No third party - the biggest advantage of smart contracts

Smart contracts solve the most important problem that arises during a transaction - the issue of trust between the parties, as well as between the parties and intermediaries. They work automatically, are convenient to use and ensure that the operation is performed correctly. They can be easily used to confirm transactions in various ways. For example, in order to secure funds for the worst-case scenario, it is enough to create a transaction that will be executed from the machine if it is not cancelled in the prescribed time. This makes smart contracts more convenient than traditional methods. For the latter, it is necessary to use a third party in the form of an independent institution to ensure the correct execution of the contract or simply mediate in the execution of the contract or transaction. This creates the problem that a party to a contract has to give such an institution credit. Unfortunately, this is not always a good solution. Often there are obstacles or problems in the form of e.g. delays in execution or transfer of funds from one account to another. Smart contracts solve this problem one hundred percent. They eliminate a third party from circulation.

Advantages and disadvantages of smart contracts

Advantages:

  • Security - the unique code on which the smart contract is based works as programmed for as long as the blockchain exists and functions. This makes it possible to create decentralized applications that are resistant to server interruptions and, above all, tampering.
  • Open-source character - the code on the basis of which smart contracts are created is very often open-source and everyone can have access to it. This makes it possible to check its claims by other users and makes the implementation of malware much more difficult.
  • Eliminating from circulation intermediaries, which are necessary during traditional transactions. There is no need to involve a lawyer, notary or real estate agent.
  • Autonomy and lack of credit of trust towards the parties - when the conditions of the agreement are met, it is executed automatically without the participation of users and third parties. Data or assets are automatically recorded in the blockchain.
  • Precision - smart contracts can control the transaction themselves. The latest generation of smart contracts are also equipped with a mechanism for detailed verification of the correctness of the records.
  • The lack of intermediaries is extremely attractive in the case of such industries as: law, logistics and real estate.
  • Speed and efficiency - direct transactions between the parties without the participation of third parties enable a significant reduction in costs, while streamlining transaction processes. Smart contracts shorten time-consuming procedures related to the transfer of documentation in paper form.

Disadvantages:

  • Difficult modifications can make smart contracts impossible to repair in case of code errors. Once a smart contract has been launched on a blockchain, it is very difficult to modify it. Smart contracts are generally responsible for transactions on assets. This means that one mistake can cost millions of dollars. For example, such a situation occurred in the case of DAO hacking attack, which enabled a gap in the Ethereum code. At that time, the ether was stolen, worth about $50 million. Besides, one of the parties to the smart contract may intentionally introduce an error into the code, which will simply be beneficial for her.
  • Smart contracts and legal standards - smart contracts are a relatively new technology. There are no precedents or specific case law lines in the field of smart contracts. It is difficult to interpret them in the light of the rules currently in force in different jurisdictions, and thus it is very difficult to resolve possible disputes. For example, it is complicated to specifically identify those responsible if there are errors in the code. A judge, after analysing a smart contract, has to appoint an expert, who will be an IT specialist. As a result, the opinion of the expert, not the judge, is an unequivocal judgment in this situation.
  • Costs - their reduction in one issue results in the emergence of other smart contracts in another aspect of operation. Storing data on blockchain is still quite expensive.

Smart contracts in everyday life

A great example of how smart contracts can be used in everyday life can be the optimisation of the usual going out to the cinema. Buying a ticket through an online store or service assumes that the buyer will only receive the ticket when the seller receives the payment and authorizes the operation. This requires confidence in the intermediary institution.

A transaction made by means of smart contracts, on the other hand, means that after receiving the appropriate amount of money, the contract will immediately send the ticket to the right person. Automation systems are, of course, present in many non-blockchain services, but there is always a question of trust towards the intermediary, e.g. in the form of a bank that has failed to deliver on time. The more institutions process a given operation, the greater the chance that an error will occur in one of them that makes finalisation impossible. In the case of smart contracts, this is impossible because the exchange takes place directly between the buyer and a specific smart contract. In addition, you can immediately check whether the customer actually receives what he or she is ordering after paying a certain amount.

In addition, blockchain saves the history of receipts to the wallet and places it permanently in the database, thus preventing any attempts at manipulation. Smart contracts are simply contracts concluded in a blockchain network with thousands of witnesses in the form of computers forming the entire network. The contracts are executed immediately after the conditions are met and cannot be modified or removed.