What are smart contracts?

Smart contracts are self-executing digital agreements written in computer code that exist on blockchain networks. They have become an essential technology in the continued emergence of cryptocurrency, playing a key role in the creation and inner workings of decentralized applications (DApps).

A closer look at smart contracts

Smart contracts are coded digital agreements written to blockchain networks. Once deployed, they typically cannot be changed or deleted. This technology significantly reduces the need for trusted intermediaries when creating and enforcing agreements. Unlike traditional contracts that require lawyers to draft them and mediators to oversee disputes, smart contracts' terms are written in publicly auditable, immutable code that automatically executes when specific conditions are met.

These contracts serve as the building blocks of decentralized applications (DApps). Their interoperability allows them to be stacked, creating increasingly sophisticated products that function without oversight or involvement from intermediaries, including their creators. This characteristic has led to the phrase "money lego" being used to describe smart contract-based applications.

The origins of smart contracts

The term "smart contract" was coined by Nick Szabo, a cryptographer, computer scientist, and early digital-money pioneer. In a 1994 essay, Szabo described computerized agreements that would automatically execute when predefined conditions were met. However, the technology to implement these contracts was not available at the time.

The creation of Bitcoin changed this landscape. While Bitcoin allows for simple smart contracts, most are written for blockchains supporting more sophisticated programming languages. Platforms like Ethereum, Solana, Avalanche, Polkadot, and Cardano each enable the development of DApps using smart contracts.

Ethereum, launched in 2015, is widely credited with bringing smart contracts to the crypto space. The project aimed to extend the functionality of the pioneering blockchain technology introduced by Bitcoin in 2009. Ethereum's smart contracts run on the Ethereum Virtual Machine (EVM), a digital software responsible for code execution and smart contract deployment.

How smart contracts work

Smart contracts are typically written in programming languages such as Solidity, Vyper, and Rust, with Solidity being the most popular for coding Ethereum-based smart contracts. These languages are used to build smart contracts with predefined rules and logic, often following an "if X happens, then do Y" structure.

Once written, the code is compiled into a machine-readable format called bytecode. The blockchain can understand bytecode and execute the smart contract's rules accordingly. As users interact with a contract, the blockchain responds by automatically executing the correct action through a transaction, which is paid for using a gas fee.

How smart contracts are used

Smart contracts have become the cornerstone of much recent blockchain innovation. They have enabled developers to monetize digital artwork and collectibles and are instrumental in decentralizing the financial industry (DeFi). Some notable examples of smart contract applications include:

1. Aave: A decentralized, non-custodial borrowing and lending protocol that allows users to earn returns and borrow assets by depositing into liquidity pools. It also offers flash loans, which are uncollateralized, ultra-short duration loans.

2. Civic: A personal identity verification service that uses smart contracts to provide secure and low-cost identity verification. Built on the Solana blockchain, it gives users total control over their personal identity information.

3. Decentralized exchanges: These platforms rely on smart contracts for operating liquidity pools within their automated market makers. Smart contracts determine token prices in liquidity pools, enabling entirely decentralized trades.

The final word

Smart contracts are undeniably the backbone of the modern crypto space, fundamental to the operations of DApps and the pioneering projects built around them. By removing the need for centralized intermediaries, this technology supports a key pillar of cryptocurrency: decentralization. As demonstrated by the examples provided, smart contracts are being utilized in diverse ways, with the potential for even more innovative applications in the future. Their importance to the industry cannot be overstated, as they continue to drive innovation and enable new possibilities in the world of blockchain and cryptocurrency.

FAQ

What are smart contracts?

Smart contracts are self-executing digital agreements with terms written in code. They automatically enforce transactions on blockchain without intermediaries, ensuring transparency and security.

What is an example of a smart contract?

A classic example is a vending machine that automatically dispenses goods when payment is made, executing predefined conditions without human intervention.

Is bitcoin a smart contract?

No, Bitcoin itself is not a smart contract. While Bitcoin transactions use scripts that function similarly to smart contracts, Bitcoin is not primarily designed as a smart contract platform like Ethereum.

What is the difference between smart contracts and blockchain?

Blockchain is a decentralized ledger, while smart contracts are self-executing codes on the blockchain that automate agreements. Blockchain provides security and transparency, and smart contracts execute predefined rules automatically.