What are smart contracts on the blockchain? Getting started!

WHAT ARE SMART CONTRACTS ON THE BLOCKCHAIN? GETTING STARTED

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What Is a Smart Contract?

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At its essence, a smart contract is a self-executing program crafted to automate the steps outlined in an agreement or contract. Once activated, these contracts set in motion a series of transactions that are not only traceable but also irreversible, introducing enhanced security and transparency into the network of digital interactions. Within a specific blockchain, a smart contract comprises critical elements such as value, address, functions, and state. When given a transaction as input, it processes the associated code and initiates output events within the blockchain. The alteration of states depends on the implementation logic of its functions.

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One of the defining features of smart contracts is their ability to facilitate transactions and agreements among parties without the need for a central authority, a conventional legal system or a third-party mediator. Moreover, these contracts don't contain the typical legal language found in traditional agreements. Instead, they have coded scripts hosting a series of if/then statements and other programming elements that embody the actions inscribed within the terms of the contract. 

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Smart contracts are widely used within blockchain networks because they ensure that every party involved in a transaction fulfils their obligations. In other words, smart contracts capability to computerize transaction protocols precisely offers immediate certainty to all participants without relying on an external enforcement mechanism or causing delays. For instance, upon completion of encoded actions, a smart contract initiates a fund transfer and engages all involved parties to get confirmation on their verification. 

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The mechanics behind smart contracts involve a series of "if/when…then…" conditionals embedded in blockchain-based code. Once predetermined actions are fulfilled and verified, a network of computers (nodes) within the blockchain enacts these actions. Smart contracts can encompass various actions, from issuing tickets, registering vehicles, disseminating funds, or sending notifications. Crucially, once a smart contract is set into motion, the transaction becomes unchangeable, preventing alterations and restricting access to authorized parties only. 

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When there is an inflow or outflow of funds on a specific account, the code on all participating nodes within the network is updated to reach a consensus on the outcome. The decentralized nature of blockchain technology ensures that each network node keeps copies of all active smart contracts, along with the blockchain and transaction data. This redundancy enables secure execution without relying on a central authority, even in complex financial transactions involving unknown entities. Once the smart contract gets upgraded to its new state after a transfer, it cannot be taken back or changed. 

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While developers can create smart contracts from scratch, many organizations now offer user-friendly templates and interfaces, simplifying the process for all parties involved. For instance, Add3 offers extensive smart contract management services for Web3 projects, monitors complex processes and provides expert information. 

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The History of Smart Contracts:

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It all began in 1994 when Nick Szabo, an American computer scientist, introduced the world to smart contracts. Remarkably, this occurred an entire decade before Bitcoin, the pioneer of cryptocurrencies, debuted globally. Szabo's visionary thinking extended beyond smart contracts; 1998 he also conceptualized a virtual cryptocurrency named "Bit Gold". Interestingly, Szabo has faced persistent rumours linking him to Satoshi Nakamoto, the enigmatic creator of Bitcoin. However, he has consistently denied the claims. 

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Szabo defined smart contracts as a computerized transaction protocol that executes the terms of a contract. He aimed to revolutionize electronic transaction methods, focusing on modernizing point-of-sale (POS) systems by seamlessly integrating them into the digital dimension. For this, he discerned the application of a decentralized ledger upon which digital contracts could be built. His theory was that once the contract terms were digitally encoded, they could be automated and overseen by the network of computers in the blockchain system. This automation, in turn, would enable secure asset exchanges without needing a trusted intermediary like a traditional bank. Finally, this automation of transactions via coded applications eliminated the need for third-party involvement while significantly reducing costs, delays and possible errors. The innovation not only streamlined the transfer of digital assets but also bolstered security against malicious attacks. Furthermore, Szabo stated that synthetic assets such as derivatives and bonds could be etched into standardized contracts despite their complex structure that mixes securities and derivatives (options and futures) in various combinations. 

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Uses of Smart Contracts:

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–The application of smart contracts spans diverse industries ranging from simple agreements to complex digital transactions. 

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–One of the common uses of smart contracts is to execute the smooth flow of transactions between two parties. Take the case of a manufacturer and supplier. For instance, a supplier can establish a seamless agreement with a manufacturer who requires a steady supply of raw materials. Payments and shipments can be orchestrated precisely and triggered automatically based on predefined conditions. Thus, the entire shipment and delivery process would be streamlined. 

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-Real estate transactions, especially property transactions, have been integrated into smart contracts. Such integration eliminates the need for traditional escrow services and reduces fraud risk. 

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–Financial markets also embraced smart contracts in stock and commodity trading, lending and corporate governance. 

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-Supply chain management and healthcare are the sectors deploying smart contracts. Thanks to this innovative approach, these sectors have enhanced their transparency, traceability, data security, and dispute resolution.

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–Smart contracts are the foundation for a wide range of decentralized applications, often called "dapps". Within the ecosystem of decentralized applications, Decentralized Finance (DeFi) has become a prominent innovation for the banking sector. DeFi apps empower cryptocurrency holders to partake in complex financial transactions, including savings, loans and insurance, without traditional financial institutions. These apps not only enhance accessibility but also eliminate intermediary fees that traditional banks charge. Uniswap, Compound and USDC are notable DeFi applications that enable crypto exchange, lending and investment. 

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Pros and Cons of Smart Contracts

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Smart contracts offer numerous benefits with their unmatched blockchain technology and advanced efficiency that have the potential to revolutionize various industries. However, as much as the technology is advantageous, it also has a set of drawbacks. 

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Pros

Efficiency: Unlike traditional contracts that involve paperwork, manual processing, and error reconciliation, smart contracts operate seamlessly, significantly reducing transaction completion times. 

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Autonomy and Precision: Thanks to automation, manual processes are eliminated from the execution phase of a smart contract. This automation ensures that contractual terms are executed with pinpoint accuracy, leaving no room for misunderstandings or human errors. 

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Immutability: Once programmed, smart contracts are digital entities that cannot be altered or edited. Their code is impervious to modification, ensuring the security and integrity of the contract throughout its lifecycle.

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Transparency: Since smart contracts operate without third-party involvement, there is no need to question whether information has been tampered with for personal gain. Encrypted transaction records, shared among participants, ensure that transparency is the cornerstone of every interaction. 

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Security: Transaction records are fully encrypted, making them highly resistant to hacking attempts. Moreover, the interconnected nature of blockchain means that altering a single record would require tampering with the entire chain—a feat beyond the reach of even the most skilled cybercriminals. 

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Saving: These digital agreements reduce delays and associated fees by eliminating intermediaries such as brokers and lawyers. The paperwork that once burdened traditional processes becomes virtually obsolete, resulting in substantial cost savings. 

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Cons

Permanent: While the immutability of smart contracts is an advantage for security, it may also pose a risk. Once deployed, smart contracts become rigid digital entities that cannot be changed. On one side, this trait ensures the security and integrity of the contract. On the other hand, any errors or inaccuracies in the initial code are permanent and irreversible.

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Human Factor: Smart contracts may be automated but still rely on human programmers to craft their underlying code. Ensuring that the code accurately reflects the terms of the contract is crucial, and any mistakes or oversights made during programming can lead to negative consequences. 

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Loopholes: Loopholes in the coding can inadvertently allow contracts to be executed in bad faith or manipulated by malicious actors. The absence of human oversight in contract execution can augment these issues. 

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Complex Implementation: This emerging technology is still relatively new, and ongoing research seeks to understand its implications and potential pitfalls fully. As a result, developing smart contracts can be confusing and resource-intensive. 

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What is an example of a Smart Contract?

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A company can use smart contracts along the supply chain management to verify suppliers with unique blockchain identities, automate orders, track shipments and execute automatic payments upon delivery confirmation. Smart contracts monitor the exchange of goods or transactions of ownership between these two parties and verify the event. 

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What Blockchain Has Smart Contracts?

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Ethereum is the pioneer of smart contracts thanks to its Taproot upgrade, followed by Solana and Cardano as the second generation of blockchain platforms. Hyperledger Fabric by IBM and Corda are private platforms that employ smart contracts for various transactions. 

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The Takeaway

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These self-executing digital agreements, residing within the secure realm of blockchain technology, have redefined how we approach contracts and transactions. From their efficient automation and unwavering precision to the trust and transparency they bring, smart contracts are poised to revolutionize diverse industries. It is crucial to note that while challenges and complexities exist, so do opportunities for transformation and growth. Add3 is here to lend a hand when you need assistance, regardless of where you are along your blockchain journey. Check out our website to find out more about our services. 

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