Introduction to Blockchain: Smart Contracts (Part 5)
5 minutes
Beginner
Smart contracts on blockchain
Smart contracts on the blockchain are programs that are written on the blockchain and automatically execute when certain conditions are met. They use code to define and enforce the rules of the contract. Once the smart contract is deployed, it operates autonomously, and there is no need for an intermediary to ensure the execution of the contract.
When a smart contract is created, it runs on a blockchain. As we have already covered in previous articles, a blockchain is a public ledger that records all cryptocurrency transactions. Cryptocurrencies with smart contract capabilities have blockchains that can also store and execute smart contracts.
Smart contracts allow cryptocurrencies to offer much more than just the role of a digital currency that can be transferred from point A to point B. Blockchains with smart contracts can create entire systems of decentralized finance (DeFi) that can operate independently, without the need for a central authority.
Introduction to Smart Contracts
Each smart contract can be reduced to an "if-then" statement. If one or more conditions are met for the contract to be executed, then the contract is executed.
One of the original and simplest examples used to explain smart contracts is a vending machine. If you input the correct amount of money and make a selection, the vending machine will dispense the item you chose. The terms of the contract are clear and the transaction happens automatically.
While one smart contract is responsible for one action, several contracts can be combined together to solve more complex tasks. This is how decentralized applications (dApps) work, and they make smart contracts much more useful.
As an example of how a dApp works, we can look at decentralized cryptocurrency exchanges (CEX). These exchanges allow users to exchange one cryptocurrency for another using various smart contracts. Here's a brief explanation of the conditions of the smart contract that can lead to an exchange:
- If a user requests to exchange the US dollar coin (CRYPTO/USDC) for Compound (CRYPTO/COMP), the smart contract retrieves the current price and provides it.
- If the user accepts the transaction and sends the US dollar coin, the smart contract will return the connection.
Examples of using smart contracts
Smart contracts can be used in many industries, including finance, law, and gaming. Finance is a natural fit for smart contracts, and so far we have seen them used to create complex DeFi systems. These platforms provide the same types of services as financial institutions, but they are all decentralized and operate on blockchain technology.
Here are some of the ways in which smart contracts can provide financial services:
- Users can invest their cryptocurrency funds in a smart contract with a decentralized exchange to become liquidity providers.
- A decentralized exchange uses these funds to facilitate cryptocurrency trading and lending.
- People can exchange cryptocurrencies or deposit and receive credit on an exchange. Smart contracts perform these transactions and charge a transaction fee.
- Liquidity providers receive transaction fees as a reward for providing their cryptocurrency funds.
With a series of smart contracts, a decentralized exchange achieves this without a central governing body. Banks or payment systems are not involved in transactions. Users can trade cryptocurrencies, borrow or lend and earn interest, all without intermediaries.
Smart contracts are also well-suited for the legal field. If they eventually become legally binding contracts, then smart contracts can reduce the time and costs associated with performing business transactions.
We cannot discuss use cases of smart contracts without mentioning non-fungible tokens (NFTs), which have become extremely popular. NFTs are any type of unique digital asset stored on the blockchain. Smart contracts record and store the unique information of NFTs. Information regarding ownership rights is also recorded using smart contracts.
Many NFTs are essentially collectibles, such as digital art, but that is not their only purpose. In blockchain games like Axie Infinity, there are characters represented as NFTs. When players buy a new character, they are purchasing an NFT with statistics and other information stored on the blockchain as a smart contract.
Advantages of smart contracts
Here are the biggest advantages of smart contracts:
- They are an economically efficient way of doing business. Since smart contracts operate on their own and execute automatically, they reduce the need for intermediaries. No one needs to confirm the fulfillment of contract terms or pay for the contract manually, which means that smart contracts can be used without unnecessary fees.
- They're fast. A smart contract can be executed immediately when its conditions are met. The waiting time is almost negligible, and this is one of the reasons why these contracts work so well for financial services and cryptocurrency trading.
- They provide complete transparency. Each smart contract has clear conditions that all involved parties can review and agree upon. Smart contracts are also irreversible, so after they are executed, no one can dispute the results.
- They inspire trust among all participants. Smart contracts eliminate the possibility of bias that could affect an agreement. The terms cannot be manipulated in favor of one party or the other. The only thing that matters is the adherence to the terms.
Given how smart contracts can improve the traditional contract system, it's worth considering them when deciding which assets to purchase.
Final Chapter: Blockchain Extensions
As of today, the articles cover topics that are used by most blockchain platforms and smart contracts. However, some second-layer extensions and protocols have been developed to address the limitations of blockchain. The final article in this series will discuss some aspects of the security of these technologies.
Read Part 6 - Extensions
