Smart contracts are software programs that are running on a decentralized/distributed network, designed to exchange funds, property, goods, and anything else of value programmatically. They are self-executing and self-enforcing contracts.
Smart contracts contain predefined rules that must be adhered to before execution. These rules are enforced by code that are trackable and irreversible. A popular example of how a smart contract works is a vending machine. Software program in the vending machine analyzes rules or conditions and executes based on those rules. One enters a coin and selects their choice of beverage. The vending machine ensures the correct funds are provided and a valid selection is made (conditions are met). The vending machine then provides the beverage (execution) to the customer. All this occurs programmatically. There is no intermediary involved which saves time, money and an opportunity for human error.
A food delivery service that operates on the blockchain could guarantee delivery in 30 minutes. The customer would pay for the food using the smart contract. The contract would put the funds into a holding state or escrow. If the delivery has been received before the agreed upon time – the funds are released from holding and to the food vendor. If delivery is late, the funds are released from holding back to the customer.
Benefits of smart contracts
All transactions executed by smart contracts are completely visible. Once the transactions are complete, it is recorded on all systems that are part of the smart contract’s blockchain.
If developed correctly, transactions in a smart contract use industry standard encryption to secure its transactions. This makes hacking into transactions extremely difficult.
Smart contracts are written as computer code. This reduces risks of human made errors when implementing and executing the contract.
Smart contracts eliminate the need for intermediaries because they are trustless programs operating on a decentralized/distributed network. They do this by delegating trust among the actors in the blockchain system that incentivizes the actors to cooperate with the rules defined by the smart contract. These contracts are fully automated and get executed when specific conditions are met. The smart contract code is fully visible on the blockchain once it’s on the network. Meaning participants can see exactly which rules and conditions it plays by. This makes for faster delivery times because there is no paperwork or middleperson involved.
Smart contracts remove the need for intermediaries such as lawyers or notaries which helps keeping costs down.
Smart Contract Applications
Smart contracts have wide ranging use cases which transcend industry. Since smart contracts are digital contracts that is responsible for some form of exchange, it has the potential to revolutionize how we do business. Manufacturing, Healthcare, and Finance are some industries, to name a few, which would benefit greatly from the use of smart contracts.
Supply Chain Management: Organizations can use smart contracts for visibility into a product’s supply chain. Businesses will have complete visibility where each component of a product was sourced. This achieves great transparency. Take a company which wants to know if a product they produce has parts sourced in a country known to have poor working conditions.
Smart contracts would provide that level of visibility allowing the company to make more informed business decisions on where products are sourced from.
Finance: This is an area where smart contracts are becoming increasingly useful. Smart contracts are being developed to replace and provide wider access to traditional financial services like lending, insurance, and trading. All without a centralized entity like a bank to manage the transactions. See our article on Decentralized Finance which goes into greater detail on these use cases.
HealthCare: Storing medical records on a blockchain using smart contracts can reduce the complexity of accessing this information for medical practitioners and patients. Currently, patient records can be stored in many databases making it more complicated to gather all the patient’s information due to differing restrictions and security controls. By storing medical records on a secure blockchain using smart contracts can make this information more readily available even as patients move between hospitals, municipalities and even countries. The patient’s records would only be accessible via their ‘private key’. This key would only be kept with the patient and if the patient can produce this, their records can be accessed from anywhere.
Areas of Improvement
Smart contracts are still in its infancy and, as a result, there are issues with them that are currently being improved on. Two biggest areas to resolve are:
Cost and scalability of smart contract transactions
Transactions costs are based on how busy the network the smart contract runs on is. Today, most smart contracts run on the Ethereum blockchain. This is especially true of DeFi based smart contracts. This has contributed to how busy the Ethereum network has become which, in turn, have raised transaction prices. This high transaction cost combined with lengthy delays in smart contract execution is a poor user experience. This high cost will be in inhibitor to smart contract adoption on Ethereum blockchain. However, there are now solutions being actively developed to take aim at these issues. These scaling and cost solutions can be classified as Layer 1 and Layer 2. Layer 1 solutions improve the base technology itself, for example, Ethereum is now moving to a Proof Of Stake consensus algorithm. Which supports faster transaction speeds and better use of computing power. There are also “Layer 2” solutions that are blockchains on top of Ethereum that inherit the same security of the underlying blockchain, while implementing faster transactions. Both intend to make it less expensive for the user to interact with Smart Contracts.
Security vulnerabilities in the code
Smart contracts can contain programming flaws if not designed with security in mind. This can allow cyber criminals to exploit these vulnerabilities. A well-known example of a successful cyber-attack on a smart contract is the DAO smart contract hack where cyber criminals were able to steal $150M in ether. As smart contract development and security matures, these vulnerabilities will be addressed.
Smart contracts have the potential to transform how we conduct business. It will impact many, if not all, industries on how exchanges are performed. There are still areas to improve in smart contract technology which are being addressed. The upside to this technology is well worth investing in and with the emergence of new and better blockchains, tokens, and platforms, it is exciting to see how this technology will benefit consumers and businesses alike.