What Are Smart Contracts?
Why might reams of paperwork and human agents soon be useless relics when securing mortgages and loans?
Updated September 16, 2021 • 2 min read
Smart contracts are a foundational technology in blockchain and a key element of the Ethereum network. A smart contract is self-executing code that carries out a set of instructions, which are then verified on the blockchain. These contracts are trustless, autonomous, decentralized, and transparent; they are irreversible and unmodifiable once deployed. Quite popular in decentralized finance (DeFi), they have several other use cases. Smart contracts can be bundled into decentralized applications (dApps) to execute more complex functions.
Like traditional contracts, smart contracts are agreements between two or more parties where one party offers something of value to another and the offer is accepted. The difference is that a smart contract is self-executing code that carries out the terms of the agreement. This code is sent to an address on a blockchain as a transaction, where it is verified by that blockchain’s consensus mechanism. Once this transaction is included in a block, the smart contract is initiated and irrevocable.
Smart contracts remove the need for intermediaries and contract enforcement. This greatly reduces cost and simplifies the contract negotiation process. With a smart contract, the code defines the mechanisms of the transaction and is the final arbiter of the terms. The immutability and irrevocability of the code in smart contracts is a strength, but comes with drawbacks. For example, if there is a bug in the code, there is no way to invalidate or change the smart contract.
Smart contracts are trustless, autonomous, decentralized, and transparent. They are also irreversible and unmodifiable once deployed. This functionality has been utilized to make smart contracts the building blocks of hundreds of decentralized applications (dApps) and a major focal point of blockchain development in general.
Ethereum: The First Mover
The idea of smart contracts actually predates blockchain and cryptocurrency, and was first proposed by developer Nick Szabo in 1994. Although the launch of Bitcoin in 2009 made smart contracts a technical reality, it was the Ethereum protocol that elevated the tech to a foundational element of blockchain.
While simple smart contracts — like multisig wallets — are possible on Bitcoin, the more versatile and complex smart contracts widely discussed today are primarily found in Ethereum’s fast-proliferating ecosystem of dApps that make up the decentralized finance (DeFi) ecosystem. Concurrently, many other projects are building Layer-2 solutions to improve upon Ethereum’s capacity for execution of smart contracts. These projects are adding features such as increased throughput, lower transaction costs, and privacy enhancements. There are also several blockchains such as Cardano, EOS, and Chainlink that are assertively expanding smart contract use cases and market share, and further developing the technology.
Smart Contract Use Cases
A solitary smart contract can only be used for one transaction type: if something happens, then something else happens. But, most dApps work by bundling smart contracts together to enable sophisticated functionality. There are thousands of dApps across the various blockchain networks, ranging from finance to gaming, exchanges, and media — and they all utilize smart contracts in different ways.
In the DeFi sector, smart contracts allow for interest on deposits and loans and trading and investing, typically only available through traditional financial services organizations. Further, smart contracts can be set up for trading, inventory tracking, prediction markets and betting, digital identity, legal contracts, online auctions, automated mortgages, and an ever-growing number of use cases.
Smart Contracts and dApps Are Here to Stay
While smart contract technology is iterative, it has already shown immense utility throughout multiple phases of blockchain and continues to develop at a rapid pace. Trustless enforcement of contractual obligations executed over the blockchain may very well be commonplace in the near future and the notion of paperwork and intermediaries being essential in mortgages, car loans, and certain financial instruments may soon be a thing of the past.
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