What are Smart Contracts and How to Read Them?
Like all other contracts, smart contracts set the terms of an agreement or contract. On the other hand, what makes smart contracts "intelligent" is that terms are set and executed in the form of code running on a blockchain rather than paper on a lawyer's desk. The basic idea behind Bitcoin is to make it possible to send and receive money without a "trusted intermediary" like a bank.
Smart contracts take this basic idea one step further, securely automating and virtually decentralizing any transaction and contract, no matter how complex. It also offers security, reliability and unlimited accessibility as it runs on a blockchain like Ethereum.
Why Are Smart Contracts Important?
Smart contracts allow developers to create a wide variety of decentralized applications and tokens. It is used in a wide variety of fields, from new financial instruments to logistics and gaming experiences, and is stored on the blockchain like any other crypto transaction. Once a smart contract implementation is added to the blockchain, it generally cannot be reversed or modified (though there are some exceptions).
Smart contract-powered apps, often called “decentralized apps” or “dapps,” include decentralized finance (or DeFi) technology aimed at transforming the banking industry. DeFi applications allow cryptocurrency holders to engage in complex financial transactions such as savings, loans, and insurance from anywhere in the world, without any bank or other financial institution taking part in the transaction. Some of the currently popular apps powered by smart contracts include:
- Uniswap: A decentralized exchange platform that allows users to exchange certain types of crypto via smart contract without any central authority that sets the rates.
- Compound: It is a platform that uses smart contracts to enable investors to earn interest without the need for an intermediary bank and to enable those who want to borrow instant loans.
- USDC: A cryptocurrency pegged to the US dollar through a smart contract that equates the value of one USDC to one US dollar. USDC is a new category of digital money known as stable cryptocurrencies.
What is the Connection Between Smart Contracts and Cryptocurrencies?
There is no doubt that one of the most important reasons for the real rise of smart contracts is the rapid development of blockchain technology. This technology allows smart contracts to use their full potential for automation.
Fueling this technology, Bitcoin has led to the establishment of Ethereum, a more sophisticated blockchain platform that allows for more complex transactions (beyond money or Bitcoin transfers). Ethereum has developed its own coding language called “Solidity”. Blockchain technology demonstrates how a network can be set up so that once a transaction is triggered, the network can autonomously generate outputs without the direct intervention of any party or any intermediary.
Not only does the blockchain allow every transaction to be verified via nodes (computers on the chain), but contracting within a 'block' and sending it to each node makes execution automatic and in principle immutable. Thus, it allows for 'digitalizing trust through certainty of execution' and creating efficiencies through 'removing middlemen' and reducing the costs associated with these.
How Do Smart Contracts Work?
Currently, the most popular smart contract platform is Ethereum, but many other cryptocurrency blockchains (including EOS, Neo, Tezos, Tron, Polkadot, and Algorand) can run them as well. The smart contract can be created by anyone and implemented on a blockchain. Their codes are transparent and verifiable by anyone. That is, all interested parties can see exactly what logic the smart contract follows when it receives digital assets.
Smart contracts are written in various programming languages (including Solidity, Web Assembly, and Michelson). The code for each smart contract on the Ethereum network is stored on the blockchain. Thus, all interested parties can review the code and current status of the contract to verify the function of the contract.
Each computer (or "node") in the network stores a copy of all existing smart contracts and their current state, as well as blockchain and transaction data.
When a smart contract receives a resource from a user, the code of the contract is executed by all nodes in the network to reach a consensus about the result and the resulting value stream. This is what allows smart contracts to operate securely without a central authority, even when users make complex financial transactions with unknown parties.
To run a smart contract on the Ethereum network, you usually have to pay a fee called "gas" (so named because these fees keep the blockchain running).
Once implemented on a blockchain, smart contracts often cannot be changed, even by their creators. (There are exceptions to this rule.) This helps ensure that smart contracts cannot be censored or shut down.
What are the Usage Areas of Smart Contracts?
Since the smart contract originated with Ethereum, it is still widely used in the banking and finance industries. However, Jerry Cuomo, vice president of blockchain technologies at IBM, believes that smart contracts can be used across the entire chain, from financial services to healthcare to insurance, and stated that the areas where smart contracts are used are opening up to many different industries. Some examples are listed below.
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