Smart contracts, in their current form on the Ethereum blockchain, are a fundamental building block for the growing Web3 industry. They underpin a wide range of applications including DeFi , NFT , games and more, playing a key role in their growth and prominence in the Web3 realm. Smart contracts, which serve as the foundation for decentralized applications on the blockchain, are critical for developers, allowing them to codify agreements between parties, automate decentralized exchanges, and create both fungible and non- fungible tokens.
Smart contracts represent the evolution of traditional contracts in the digital age. Written in a virtual language, they are capable of executing and enforcing themselves autonomously and automatically based on programmed parameters. The integration of blockchain technology increases their value by enhancing security, transparency and trust among signatories. This eliminates the risks of misunderstanding, tampering or alteration and reduces the need for intermediaries. The promise of smart contracts lies in their potential to simplify complex processes such as buying a house, which typically involves banks, notaries, land registries and extensive documentation. With blockchain and smart contracts, these processes can be simplified, increasing trust, security and transparency between the parties involved.
What is a smart contract?
The smart contract is a revolutionary innovation in blockchain technology, conceptualized in the 1990s by Nick Szabo, an innovator in modern computer science. Sabo, who also invented the virtual currency Bit Gold in 1998, defined smart contracts as virtual promises with protocols to enforce them. While the Bitcoin protocol can be seen as an elementary form of a smart contract, the creation and implementation of these contracts has become much simpler with the advent of Etherium.
Smart contracts function as automated programs or protocols on the blockchain, activating when certain predefined conditions are met. These self-executing contracts, written directly into the code, detail the terms of agreements between buyers and sellers. They play a key role in making transactions traceable, transparent and irreversible, thereby eliminating intermediaries and reducing time delays.
Placed on blockchain networks, smart contracts contain certain conditions that lead to certain outcomes. Their decentralized nature in blockchains ensures accuracy, timeliness and security, making them tamper-proof. This technology is crucial for automating multilateral digital agreements, reducing risks, increasing efficiency, reducing costs, and increasing transparency in various processes.
Moreover, smart contracts go beyond automating contractual actions. Sabo, often considered the real Satoshi Nakamoto (a claim he denies), saw these contracts as mechanisms to extend electronic transaction methods such as POS (point of sale) into the digital sphere. He foresaw their use in complex financial instruments such as derivatives and bonds, enabling complex payment term structures and minimizing transaction costs.
Smart contracts on blockchain are self-executing scripts that automate contractual obligations. They do not contain traditional legal language, but consist of program commands that perform actions when certain conditions are met. These innovative contracts, pioneered by Sabo, have changed the way digital transactions and agreements are conducted, heralding a new era of efficiency and security in the digital world.
How do smart contracts work?
Smart contracts, essentially tamper-proof programs hosted on blockchains, operate on the fundamental logic of “if/when event x occurs, perform action y.” These contracts can cover multiple conditions, and a single application can combine multiple smart contracts for a complex network of processes. Developers can create and deploy these contracts on public blockchains for a variety of purposes, including personal finance applications such as automated yield aggregators.
The appeal of smart contracts lies in their ability to facilitate secure transactions between independent and often anonymous parties without the need for central authorities or legal systems. While Ethereum is currently the leading platform for smart contracts, other blockchains such as EOS, Neo, Tezos, Tron , Polkadot and Algorand also support them. Smart contracts on Ethereum and similar networks are written in various programming languages such as Solidity , Web Assembly and Michelson . Their code is stored on the blockchain, making it transparent and publicly verifiable, allowing anyone to check the contract code and its current working state.
Each node in the network keeps a copy of all smart contracts along with the blockchain and transaction data. When a smart contract receives funds, all nodes execute its code to reach consensus on the outcome, ensuring secure transactions without a central authority. To execute a smart contract on networks such as Ethereum, users typically pay a fee called ” gas”.
Smart contracts work by adhering to simple “if/when… then…” operators encoded in the blockchain. They autonomously perform actions such as releasing funds, registering assets, or sending notifications when conditions are met. The immutable nature of the blockchain ensures that these transactions are permanent and visible only to authorized parties. These contracts may include numerous provisions requiring participants to agree on the representation of transactions on the blockchain, governing rules, potential exceptions, and dispute resolution mechanisms.
Notably, not all blockchains can run smart contracts. While some, including Ethereum, Arbitrum , Avalanche, Base, BNB Chain , support them, others, such as Bitcoin’s underlying blockchain, do not. The difference lies in the blockchain’s ability to execute and store arbitrary logic. Once implemented, smart contracts tend to remain immutable even to their creators, with a few exceptions, providing resistance to censorship or disabling.
Insurance
Parametric insurance is a type of insurance in which the payout is directly tied to a certain predetermined event. Smart contracts provide a tamper-proof infrastructure for creating parametric insurance contracts triggered by input data. For example, crop insurance can be created using smart contracts when a user purchases a policy based on specific weather information such as seasonal precipitation in a geographic location. At the end of the policy, the smart contract will automatically issue a payout if the rainfall at a particular location exceeds the original amount claimed. Not only do end users receive timely payouts with less overhead, but the insurance offering side can become open to the public through smart contracts. A smart contract allows users to contribute funds to a pool and then distribute the collected premiums to pool participants based on the percentage of their contribution to the pool.
