Sep 6, 2021
Blockchain technology has primarily manifested itself in the minds of the masses as the fundamental building block of cryptocurrencies. However, while cryptocurrencies alone are a veritable economic game changer, the real paradigm shift comes with smart contracts.
Smart contracts are a set of digitally signed instructions that are stored on a blockchain and contain conditions which when met, execute a series of predefined transactions. Due to the contract being enforced automatically and unequivocally by the decentralized network, this provides a simple, elegant, and flexible solution that is ubiquitous in replacing orthodox contracts. Transactions and digital sales, financial products and lending, inter-institutional contracts, and now, with the advent of tokenization, even the transfer of physical assets can all be automated trustlessly through smart contracts.
How do Smart Contracts Work?
Any blockchain network that indigenously supports smart contract creation is a viable candidate to host and enact a digital commitment. The participants involved may frame a contract that appeals to all parties and satisfies the conditions that are put forward for initiation, completion, and execution of the contract. Once the contract has been digitally signed by all parties, it is immutably in effect and available on the blockchain. It cannot be cancelled or reversed, making it the most secure and hassle-free form of enforcement possible. All of this is taken care of for an expense that is magnitudes lower than it would have taken through conventional means.
As a practical example, consider a case study of cryptocurrency lending, where John believes in an upcoming bull market for a cryptocurrency, say Ethereum, and wishes to hold on to their Ethereum assets with the expectation of appreciation. However, either John does not want to leave a chunk of their financial assets tied up in cryptocurrency or they temporarily need to tap into their invested assets with the intention of reinvesting into Ethereum. Unfortunately, John faces a risk of Ethereum rising in value while he has temporarily withdrawn his investment.
Enter Jane, a completely anonymous cryptocurrency lender who is willing to loan, at an interest, a stable cryptocurrency such as USDT in exchange for John’s Ethereum as collateral. This would allow John to collect their Ethereum regardless of price fluctuation as long as they return the borrowed USDT with interest.
Without smart contracts, such an arrangement would forever remain an impractical idea. Thanks to the advent of standardized loaning smart contracts, John can put his Ethereum into escrow, Jane can earn interest on her capital and neither has to worry about trusting each other. The smart contract, now duplicated on every node in the blockchain network, will automatically turn over John’s Ethereum to Jane if the USDT is not returned with interest by a mutually agreed upon date. Likewise, as soon as John remits the borrowed amount with interest, the network recognizes the completion of the contract and refunds John with the escrowed Ethereum.
Types of Smart Contracts
Legal smart contracts function as supplements to physical, legally binding contracts. While they can effectively represent any legal contract themselves, modern legal institutions are not yet accommodating of relying solely on digital contracts.
Decentralized governance of the blockchain or voting using the blockchain can be performed through smart contracts that are tied in at the root of the chain,
Decentralized Apps (DApps) are programs, games, or user interfaced applications that write and thereby lock in part of their results with the blockchain, ensuring that the app runs on the chain as long as the network lives. With greater efficiency in networks such as Ethereum 2.0, the complexity of on-chain DApps can increase to replace conventional apps running on servers. As of now DApps are a great way to set up and leave an app running and accessible to everyone without any maintenance from the owner.
IOT smart contracts provide the interface between IOT devices and the blockchain network they are integrated with. This ensures that the data from the sensors is recorded and administered in a tamper proof way.
Considering how smart contracts can upheave the way most institutions do business, and how large numbers of individuals are already using them in their daily lives, it’s no surprise that corporations are looking into ways of integrating smart contracts into their pipelines to increase both efficiency and trust. Going forward, DApps will form the normalized systemic cog for every practical use case, functioning at an organizational layer above blockchain. The only question is, which corporations will reap the advantages of trustless automated systems fast enough to stay relevant?