A smart contract is an application or programme that operates on a blockchain in the domain of cryptocurrency. Typically, they function as a digital agreement governed by a set of rules. These rules are defined by computer code, which is duplicated and executed by all network nodes.

Smart contracts on the blockchain enable the establishment of trustless systems. This means that two parties can create agreements on the blockchain without knowing or trusting one another. They can be assured that if the terms aren’t met, the agreement will not be executed. Aside from that, smart contracts can eliminate the need for intermediaries, drastically lowering operational costs.

Although the Bitcoin protocol has supported smart contracts for several years, they were popularised by Vitalik Buterin, the creator and co-founder of Ethereum. It’s worth mentioning, though, that each blockchain may use a different approach to smart contract implementation.

This blog will mainly focus on the smart contracts that run on the Ethereum blockchain.

How do Smart Contracts work?
A smart contract is a deterministic code/algorithm in simple terms. When and if certain circumstances are met, it performs a specific task. As a result, “if… then…” expressions are frequently used in smart contract systems. Smart contracts, contrary to popular belief, are neither legal nor smart contracts. They are nothing more than a piece of code that runs on a distributed system (blockchain).

Smart contracts are in charge of performing and managing blockchain actions that occur when users (addresses) engage with one another on the Ethereum network.

Ethereum smart contracts are made up of two public keys and a contract code. The initial public key is that provided by the contract’s creator. The contract itself is represented by the other key, which serves as a digital identity for each smart contract.

Key Characteristics of Smart Contracts
Immutable: After they’ve been deployed, smart contracts can’t be altered. Only if a certain function was previously implemented can they be “removed.” As a result, smart contracts can provide tamper-resistant coding.

Distributed: The Ethereum network’s smart contracts are duplicated and disseminated across all nodes. This is one of the primary differences from other centralised server-based solutions.

Autonomous: Smart contracts behave like a self-executing computer and may automate a wide range of tasks. In most circumstances, though, if a smart contract isn’t activated, it will remain “dormant” and do nothing.

Deterministic: Smart contracts only carry out the tasks for which they were created, as long as the conditions are met. Furthermore, regardless of who implements them, the result will always be the same.

Transparency: Smart contracts’ source code is not only immutable but also public because they are constructed on a public blockchain.

Customisable: Smart contracts can be coded in a variety of ways before being deployed. As a result, they can be utilised to build a variety of decentralised applications (DApps).

Trustless: It allows two or more parties to engage without knowing or trusting one another. Furthermore, blockchain technology ensures data accuracy.

Advantages of Smart Contracts
Smart contracts, being programmable code, are extremely flexible and may be designed in a variety of ways to provide a variety of services and solutions.

Smart contracts, as decentralised and self-executing programmes, may give improved transparency and lower operational expenses. They can also improve efficiency and cut bureaucratic costs, depending on how they’re implemented.

Smart contracts are especially beneficial in cases where two or more parties must transfer or trade funds. Additionally, they may find applications in almost all industries namely; healthcare, insurance, broking, technology, finance, etc. One of the prominent use cases being tested currently is quick insurance claim settlements via this technology.

Limitations of Smart Contracts
Smart contracts are made up of human-written computer codes. As a result, there are several dangers because the code is vulnerable to errors and vulnerabilities. They should, in the ideal world, be designed and deployed by skilled programmers, especially when dealing with sensitive data or big sums of money.

Aside from that, some say that centralised systems can provide most of the smart contract’s solutions and features. Smart contracts, on the other hand, execute on a distributed P2P network rather than a centralised server. And, because they’re built on the blockchain, they’re either immutable or extremely difficult to change.

Being “immutable” might be beneficial in some situations but detrimental in others. For example, millions of ether (ETH) were stolen when a Decentralised Autonomous Organisation (DAO) named “The DAO” was hacked in 2016 due to weaknesses in their smart contract design.

Developers were unable to fix the code since their smart contract was immutable. This resulted in a hard fork, resulting in the formation of a second Ethereum chain. One of the chains reverted the hack and returned the funds to their legitimate owners (this is part of the current Ethereum blockchain). The other chain chose not to intervene in the hack, claiming that events on a blockchain should never be altered (this chain is now called Ethereum Classic).

It’s worth noting that the issue was not caused by the Ethereum blockchain. Instead, a defective smart contract implementation was to blame.

Another disadvantage of smart contracts is their ambiguous legal status. Smart contracts are not only illegal in most countries, but they also don’t fit into the current legal structure.

Many contracts, for example, demand that both parties be properly identified and are over the age of 18. The lack of intermediaries paired with the pseudonymity afforded by blockchain technology may jeopardise those criteria. There are potential solutions that can be tried and implemented to overcome these challenges. The legal enforceability of smart contracts remains another hurdle, particularly in borderless and distributed networks.

Final Thoughts
Smart contracts have undoubtedly had a significant impact on the world of cryptocurrencies, and they have certainly transformed the blockchain sector. Smart contracts will likely enable a wide range of applications in the future, ranging from financial services to supply chain management, even if end-users do not interact with them directly.

Smart contracts and blockchain, when used together, have the ability to alter practically every aspect of our lives. However, only time will tell if these disruptive technologies will overcome the numerous challenges to their wide-scale implementation.

Manit, our Crypto Techie, has been in the space for a decade building strategies that keep his adrenaline rushing. When he’s not at the work desk, he loves travelling and binge-watching movies.

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