UNDERSTANDING SMART CONTRACTS

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TABLE OF CONTENT

WHAT ARE SMART CONTRACTS

Smart contracts are algorithmic procedures that automate contract processing, including deal-making, real estate transactions, and the frictionless movement of money and papers. 

Smart contracts guarantee direct transactions between relevant parties by eliminating the need for middlemen like brokers, agents, and notaries. 

Developers can construct the business logic to direct these contracts before installing them on the blockchain, making them independent and free from third-party control. They operate like self-executing code, running when particular conditions are satisfied.

HISTORY OF SMART CONTRACTS 

The idea of smart contracts was first put forth in 1994 by American computer scientist Nick Szabo, who in 1998 invented a digital currency dubbed “Bit Gold” and was thus 10 years before Bitcoin. He dismisses the rumors that he is the real Satoshi Nakamoto, who anonymously invented Bitcoin.

To bring POS and other electronic transaction methods into the digital realm, Szabo’s notion of smart contracts included computerized transaction protocols to carry out contract conditions. He also suggested using derivatives and bonds as contracts for synthetic assets.

According to Szabo’s study, integrating bonds and derivatives in different ways would result in new securities that could be traded with low transaction costs due to automated analysis. These new securities would have complex term structures for payments and be included in standardized contracts. As seen by the widespread usage of computer networks for derivatives trading with complex term structures, many of his predictions in the study have come true even before the emergence of blockchain technology.

HOW DO SMART CONTRACTS WORK

With the help of “if/when…then” scripting, smart contracts run on blockchains. A network of computers will execute the required operations, such as disbursing payments, registering a vehicle, providing alerts, or generating tickets, after particular criteria are met and validated. The blockchain is updated when a transaction is complete to ensure that parties can only see the results with permission and that they cannot be modified.

Participants may include different criteria in a smart contract to ensure satisfactory task fulfillment. They must agree on transaction representation, establish rules for those transactions, consider exclusions, and outline the dispute resolution procedure. Several organizations now offer templates and online tools to make the process easier for businesses adopting blockchain, even though professionals can develop smart contracts.

REAL-WORLD USE CASES OF SMART CONTRACTS

The concept of Smart Contracts can, in fact, be applied in real life just as much as it is in the digital world. Here are some relatable cases where Smart Contracts can be used in real life.

  1. Trading Transactions

By automating the function of middlemen or brokers, smart contracts offer a useful use in trade finance, expediting trading activities. As a result, the expenses related to intermediaries are removed, making it a more and more common option for many businesses.

  1. Electronic Identity 

Smart contracts are widely used in digital identity, providing users with benefits, including reputation management, data storage, and digital asset management. People can open up new prospects, secure their identity from counterparties, and share it with reputable companies by appropriately exploiting digital identity.

Internet users can currently access various services, but they can unintentionally reveal their identity to affiliated businesses.

By allowing counterparties to learn about people without learning their genuine identities or by authenticating transactions, smart contracts can solve this problem. Through the use of smart contracts, this seamless solution to KYC improves compliance, robustness, and interoperability.

  1. Escrow 

Escrow services include keeping money between parties in trust until the terms of the agreement are met. When the service provider completes and validates their work, smart contracts can automate the process of releasing funds. Smart contracts, which many businesses have already adopted, can be used by Upwork and other freelancing sites to manage escrow sums.

  1. Superior Securities 

In the area of securities, smart contracts have valuable applications as well. Eliminating intermediaries like security custody chains makes capitalization table administration simpler and better. In addition, smart contracts can handle stock splits, automatic payments, dividends, and obligation management, reducing operational risk and streamlining operations.

  1. Maintaining Financial Data

Smart contracts are essential for storing financial data because they enable enterprises to collect data accurately and transparently. They provide uniform data recording, which lowers auditing and accounting expenses and enhances interoperability between distributed ledger networks and traditional networks.

  1. A Better Cross-Border Payments System

Trade Finance could experience a revolutionary development by utilizing smart contracts. These agreements use Letters of Credit to facilitate the transfer of products internationally and the beginning of trade payments. 

Using smart contracts will increase the liquidity of financial assets, resulting in better financial efficiency for vendors, customers, and institutions. Finding and following a standard within the sector is essential to successfully implementing cross-border payments and international trade. Smart contracts can provide a superior method for resolving disputes and can be seamlessly integrated to meet legal issues.

  1. Government

Government operations can benefit from smart contracts’ automation, which includes recording land titles for quick and transparent property transactions. Governments can lower the cost of auditing and increase system transparency by implementing smart contracts. Smart contracts can also be used for electronic voting, digital identity verification, and electronic record keeping, giving governments a variety of use cases based on their unique requirements.

  1. Trials In medicine 

Smart contracts can improve visibility across institutions and automate data sharing while protecting privacy for clinical trials. Clinical trials are one instance of this application in real life.

Smart contracts also make it easier to share information across businesses and automate trial procedures. They assist with data authentication, identity verification, and permission.

  1. Insurance 

Like the financial sector, the insurance industry has long been seen as a good use case for smart contracts due to the high frequency of disputes. Insurance processes can be accelerated and streamlined with the help of smart contracts, especially with the aid of IoT-related technology. Smart contracts can help with insurance by quickly authenticating necessary paperwork, such as driver reports and driving records, once an accident happens. Fraud is less likely because of this data-driven execution method.

  1. Supply Chain Administration 

Using blockchain smart contracts for supply chain management has many advantages. The supply chain significantly improves with the implementation of smart contracts. For instance, it enables firms to improve inventory management precisely by enabling complete transparency and tracking of things along the supply chain.

Additionally, smart contracts have a good effect on many business elements that are closely related to the supply chain. As a result of their adoption, verification efforts are decreased, traceability is improved, and fraud and theft instances are reduced. However, organizations may need to incorporate extra hardware, such as sensors, into their supply chain architecture to utilize smart contracts efficiently.

  1. Loans and Mortgages Improvement

Financial services, including mortgages and loans, could be completely changed by smart contracts. The entire procedure can be carried out smoothly and error-free by establishing connections between the concerned parties. 

By way of illustration, a smart contract controlling a mortgage can effectively handle payments and release the property upon full loan payback. In addition, everybody involved in the process is made aware of it. This application demonstrates the adaptability and potency of smart contracts in the financial sector and is consistent with the use cases for Ethereum smart contracts.

  1. Record keeping

Real-world assets can be recorded and digitally preserved through smart contract databases, making it possible for records to be automatically renewed and released based on predefined criteria. This use-case illustrates how smart contracts are actually put to use in the real world.

BENEFITS OF SMART CONTRACTS

Smart contracts are very beneficial, hence the need to study and understand how they work. Some of the benefits include 

  1. Trustless

The system as a whole operates without any reliability. As a result, there is no need to rely on outside sources. Even though it could sound contradictory, it merely means that transactions don’t require the cooperation of trustworthy parties in order to be carried out. A transaction or exchange doesn’t necessarily need to include trust. Smart contracts run on a decentralized network, which makes the network as a whole trustless.

  1. Secured

Strong security measures are another impressive aspect of smart contracts. Due to their encryption, they enable secure processes and work as intended. Smart contracts run on networks with immutable data, so whatever data they produce is immutable and secure for all the data they handle.

  1. Free From Interruptions 

Smart contracts with no interruptions function continuously. Inferring that they cannot be stopped or interfered with once execution has started.

  1. Autonomous

Smart contracts’ main benefit is their capacity to automate procedures. This calls for continuous operations free of outside parties’ interference, barring agreements and judgment changes. Businesses benefit from this automation since it streamlines many areas of their operations and confidently takes care of issues in some processes.

  1. Accurate and error-free

Smart contracts display accuracy and error-free operation. The only prerequisite for flawless operation is that they are programmed precisely. There is space for error, for instance, while filing your taxes. But using a smart contract for the job ensures a perfect approach.

  1. Cost-efficient

By doing away with middlemen, smart contracts improve the cost-effectiveness of transactions. As a result, transactions move more quickly and incur less costs.

  1. Swift Execution

Finally, compared to traditional ways, autonomous smart contracts execute far more quickly. They just need matching before execution because the parameters are pre-defined.

LIMITATIONS OF SMART CONTRACTS 

As can be seen, smart contracts have advantages and drawbacks, which are discussed in more detail in the section below.

  1. Problems with confidentiality

Confidentiality concerns arise when using blockchain technology, which discloses transaction information of node activity. While this openness helps avoid fraud, some users want to restrict access to the information related to their contracts. 

A comparison can be made to the breach of confidentiality caused by concealed source code found in HTML files of websites and accessible through the View Source feature. 

Similar problems arise with smart contracts, allowing malevolent users to undermine data privacy, expose contract statuses, and damage the integrity of the blockchain. As a result, user trust is seriously damaged by the erosion of privacy within smart contracts.

  1. Security Concerns

Despite the gains, smart contracts are still prone to mistakes that can cause significant and disproportionate damage compared to ordinary software bugs. Defi platforms are largely driven by these smart contracts, suggesting that even a single vulnerability could result in significant user losses.

But as smart contracts’ security environment improves, some of the concerns are lessened. The fact that many smart contract initiatives put marketing and user growth ahead of system security is a persistent concern.

  1. Problems with External Data

A smart contract must be able to be executed, so basic data is required. For instance, a smart contract can provide that once Person B pays for particular products, Person A is to get money. The smart contract needs to know when the goods will be delivered in advance to make this possible. With this knowledge, the payment for Person A can now be processed.

However, the blockchain network’s fundamental restrictions forbid communication outside of it. For smart contracts, this constraint poses a challenge. Developers of smart contracts use oracles to get around this obstacle. Applications called oracles are in charge of obtaining outside data. After being retrieved, the information is added to the blockchain so that smart contracts can utilize it. An oracle could contribute by providing information from a third party in the aforementioned case. This information would allow the smart contract to confirm successful product delivery.

Despite this, a further problem for smart contracts is their extensive reliance on oracles. Users must trust the data produced by these oracles to be accurate and precise. Furthermore, this high reliance may result in more mistakes while using smart contracts. The “Garbage In, Garbage Out” (GIGO) principle can lead to problems for smart contracts during their initial development phase.

Utilizing information from many oracles is one possible answer to this problem. The drawback of this strategy is greater transaction costs because oracles demand money. Additionally, relying on information from different sources is not advised because it deviates from accepted norms.

It’s crucial to remember that every node in the system needs to agree with the status of the contract for the transaction to be valid. Nodes that acquire their information from various oracles could find it difficult to come to an agreement.

  1. Immutability 

Blockchains face a huge barrier in the form of immutable smart contracts. Immutability is the impossibility of changing the protocol specifications when smart contracts are live on the blockchain.

This feature makes smart contracts more difficult to use while preventing nefarious parties from changing the contract terms. This suggests that due to the inflexible structure of smart contracts, individuals wishing to amend a contract to conform to an agreement cannot do so.

Correcting code flaws is made more difficult by smart contracts’ immutability. This limitation limits developers to a finite number of fixes when addressing defects.

  1. Regulatory Issues

Legal counsel is not required for agreement witnessing or signing when using smart contracts. However, the danger is involved because there are no official legal protections for the legality of smart contracts. There is a possibility of transaction loss should one party violate the conditions of the contract.

Most smart contracts function beyond the purview of judicial control. This lack of legal support represents a significant barrier limiting the potential of smart contracts. But as smart contracts are used more frequently, this scenario might change.

A barrier to the widespread use of smart contracts will continue to be the availability of legal problems. A legal structure must yet be established to serve as a reliable mediator.

  1. Simplicity 

As they struggle to operate in speculative situations, smart contracts’ fundamental simplicity can become a restriction. To change, some contracts need major revisions. It’s imperative to stay away from cryptic code and intricate binary representation. For smart contracts, this complexity is a barrier.

For the acceptance of payments and the transfer of goods, creating a smart contract is not difficult. However, when dealing with ambiguous instructions and attempting to translate them into code, the real issue becomes apparent.

In conclusion, using smart contracts in agreements may not be appropriate in circumstances requiring the interpretation of unclear instructions. But they still see value in straightforward uses like cryptocurrency transfers. Blockchain-based data management, in this case, ensures simplicity and transparency.

CONCLUSION 

Smart contracts are ground-breaking computerized agreements based on predetermined criteria that eliminate the need for conventional middlemen like banks and attorneys. They have the capacity to produce secure, reliable systems. Although they are efficient, using them for significant transactions is dangerous, and the governing legal structures are continuously evolving. Smart contracts may greatly impact our economy and society as they become more popular.

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