What Are Smart Contracts on Blockchain?

Table of content

• What Are Smart Contracts and How Do They Work?
• The Benefits of Smart Contracts
• The Most Common Smart Contract Use Cases
• Smart Legal Contracts vs. Traditional Legal Agreements
• What Technologies Power Smart Contracts?
• Limitations and Challenges of Smart Contracts
• How Can Beginners Create a Simple Smart Contract?
• Step-by-Step Guide for Beginners to Create a Smart Contract
• Smart Contracts' Bottom Line
• FAQs about Smart Contracts on Blockchain

Computer scientist Nick Szabo first introduced the concept of smart contracts in the 1990s. He envisioned digital contracts that would automatically enforce the terms of an agreement in a decentralized manner. What we currently refer to as smart contracts—useful elements of blockchain technology—were made possible by Szabo's idea.

When certain circumstances are met, smart contracts carry out predetermined activities. For instance, in a financial contract, the release of goods or services is automatically triggered if one side transfers the agreed-upon sum. 

Smart contracts run on blockchain networks, benefiting from blockchain’s key features: decentralization, security, and immutability.

One of the primary benefits of smart contracts is the elimination of intermediaries. Traditionally, contracts require third parties like lawyers, notaries, or banks to verify, enforce, and execute the terms. It can be an expensive and time-consuming operation. 

By harnessing the decentralized nature of blockchain technology to execute agreements automatically, smart contracts eliminate these middlemen and reduce the time and expense involved with traditional contracts.

Another important advantage is security. Smart contracts are powered by blockchain technology, renowned for its high degree of security. Since data and transactions are spread throughout a dispersed network of computers, hacking and manipulation are almost impossible. 

 Additionally, the risk of fraud or error is minimized because the contract is immutable, meaning it cannot be altered once created.

Smart contracts also enhance efficiency and speed. By automating the execution of agreements, transactions that would typically take days or even weeks can be completed in seconds. This improves the user experience and reduces administrative overhead, allowing businesses to save on labor costs and increase productivity.

Many different sectors utilize smart contracts extensively to automate and optimize procedures. Financial services, namely decentralized finance (DeFi) apps, are among the most well-known use cases. 

DeFi eliminates the need for conventional banks and financial middlemen by using smart contracts to handle everything from lending and borrowing to asset trading. For instance, smart contracts are used by decentralized exchanges (DEXs) to enable peer-to-peer cryptocurrency trading.

Supply chain management is another common use case. Businesses can use smart contracts to automate procedures like payment processing and delivery confirmations and track the movement of items in real time. Once goods are delivered, smart contracts can initiate payments automatically, guaranteeing that all parties involved in the supply chain receive accurate and timely payment.

In real estate, smart contracts have been used to automate property transactions. Once the contract conditions are met, such as the transfer of funds and the completion of necessary paperwork, ownership of the property is automatically transferred to the buyer, eliminating the need for notaries or other intermediaries. 

Similarly, smart contracts transfer and verify ownership of non-fungible tokens (NFTs) or other blockchain-based assets in digital asset ownership.

While both smart contracts and traditional legal agreements aim to enforce agreements between parties, there are significant differences in how they operate. Traditional legal contracts often require intermediaries, such as lawyers, to draft, review, and enforce the terms of the agreement. 

These contracts are subject to interpretation by courts and legal authorities. If a dispute arises, traditional contracts can be challenged in court.

In contrast, smart contracts are executed automatically when specific conditions are met, and they are enforced by the blockchain. Once deployed, the terms cannot be altered, and the execution is final. 

However, there are legal challenges with smart contracts. Since they are digital and autonomous, there are questions about how they fit within existing legal frameworks. In some cases, hybrid approaches are being explored, combining traditional legal contracts with smart contracts to ensure enforceability in the physical world.

The most popular platform for smart contracts is Ethereum, which allows developers to write decentralized applications (dApps) and smart contracts using Solidity. Ethereum is widely used because of its flexibility and ability to support complex decentralized applications. 

Other blockchain platforms, like Binance Smart Chain, Polkadot, and Cardano, also support smart contracts but may use different programming languages and features.

Blockchain networks like Ethereum provide the infrastructure needed to run smart contracts. These networks maintain decentralized ledgers, allowing contracts to be stored and executed across many nodes, ensuring that no single entity controls the contract or its data. 

Despite their many benefits, smart contracts face several limitations. One of the leading technical constraints is that smart contracts can only execute what they have been programmed to do. For example, smart contracts often cannot interact with external data unless an “oracle” is used to fetch it. While smart contracts can automate simple transactions, more complex scenarios may require off-chain solutions.

Another challenge is the security of smart contract code. While blockchain is highly secure, the code written for smart contracts may contain bugs or vulnerabilities that hackers can exploit. High-profile hacks have shown that a vulnerability in smart contract code can lead to significant financial losses.

Regulatory and compliance issues also pose challenges. Because smart contracts operate autonomously and cross borders, they may run into legal and regulatory issues depending on the jurisdiction. The lack of precise regulation for smart contracts in many countries makes it challenging to understand their legal standing in various scenarios.

The first steps in creating a basic smart contract are to learn the fundamentals of a cutting-edge contract programming language, such as Solidity, and comprehend how blockchain platforms, like Ethereum, operate. Writing a simple contract with straightforward terms and conditions, such as moving cryptocurrency between parties upon fulfilling specific requirements, is a good place for beginners to start.

To create a smart contract, you must employ a development environment such as Truffle Suite or Remix, which are made to assist developers in developing, testing, and implementing smart contracts. Before implementing your contract on the most popular network, you can test it on Ethereum's test networks to ensure it works as intended.

You can also test and audit your contract using tools like Hardhat and Remix IDE to ensure it operates safely. Testing is vital to ensure the contract works as intended and is error-free or vulnerability-free.

Here is a simple guide to create your first Smart Contract:

1. Learn the Basics: Understand what a smart contract is—an automated, self-executing contract on a blockchain.
   
2. Set Up Your Development Environment: Use Remix IDE (https://remix.ethereum.org) to write and test your Solidity code directly in your browser.
   
3. Write Your First Smart Contract: Create a new .sol file in Remix and write a simple contract in Solidity, like a “store and retrieve” contract.
   
4. Compile the Smart Contract: Click the “Solidity Compiler” tab in Remix and compile your contract to ensure no errors.
   
5. Deploy the Contract: Use Remix's “Deploy & Run” tab to deploy the contract to the Ethereum test network (like Rinkeby).
   
6. Test the Contract: Interact with the deployed contract through the Remix interface to ensure it’s working correctly.
   
7. Use a Wallet: When ready, connect your wallet (e.g., MetaMask) to deploy the contract on the leading Ethereum network.

Smart contracts transform how we interact with digital systems by automating transactions and reducing the need for middlemen. Among their many advantages are greater efficiency, security, and cost savings.

However, there are still challenges due to technical constraints, security vulnerabilities, and legal issues. As the technology advances and becomes more popular, smart contracts will continue to be crucial to supply chains, digital asset ownership, real estate, and banking.