What are smart contracts? Types, benefits & use cases explained

With the advancement of IT technologies and blockchain platforms, a new type of contract has emerged: smart contracts.

In this article, we’ll explore smart contracts and how they’re being used today.

What are smart contracts. Smart contracts explained

What is a smart contract? It is like a digital agreement that runs on its own, with all the terms and conditions written directly into the code. It operates on a blockchain network, so the contract automatically carries out and enforces itself when the set conditions are met.

There’s no need for intermediaries like lawyers or banks because the contract’s rules are transparent and unchangeable once deployed. Essentially, smart contracts in cryptocurrency streamline and secure transactions, making them faster, more efficient, and less reliant on third-party oversight.

Historical background

The concept of smart contracts dates back to the mid-1990s when computer scientist and cryptographer Nick Szabo first proposed the idea.

He envisioned a digital protocol that could automatically execute the terms of a contract when predefined conditions were met, similar to a vending machine dispensing a snack when the correct amount of money is inserted.

But it wasn’t until blockchain technology came along, especially with the launch of Ethereum in 2015, that smart contracts took off. Ethereum’s blockchain gave developers the tools to create and run code that could handle complex agreements on its own. This breakthrough led to a wave of new decentralized apps, shaking things up by automating transactions and eliminating the need for middlemen.

How do smart contracts work

Smart contracts use straightforward “if/when…then…” commands written into the blockchain. They automatically handle tasks like releasing funds, registering assets, or sending notifications once conditions are met. The blockchain’s permanence ensures transactions are visible only to authorized parties.

Smart contracts can get pretty complex, involving various conditions everyone has to agree on. This means deciding on how transactions are recorded, handling any exceptions, and figuring out how to resolve disputes. 

Every node in the network keeps a copy of all the smart contracts along with the blockchain and transaction data. When a contract receives funds, all nodes execute the contract’s code to agree on the result, ensuring that everything runs smoothly without a central authority. 

Not every blockchain can run automated contracts, so it’s good to know which ones do and which don’t. While platforms like Ethereum, Arbitrum, Avalanche, Base, and BNB Chain do, others, like the base blockchain of Bitcoin, don’t. The main difference is whether a blockchain can handle and store complex logic. Once a smart contract is set up, it usually stays as is, even for those who created it. This stability helps it resist censorship and prevents it from being easily shut down.

Types of smart contracts

Smart contracts in blockchain generally fall into three types:

Smart Legal Contracts 

Smart Legal contracts are designed to align with formal legal agreements, meaning the parties involved are legally accountable for meeting the contract’s terms. These can range from contracts that facilitate cryptocurrency-to-fiat conversions to those that handle real estate registrations.

Many existing smart contracts are legal in nature, underpinning various platforms including cryptocurrency exchanges, DeFi projects, GameFi projects, and blockchain-based platforms like NFT marketplaces and real estate tokenization platforms.

Decentralized Autonomous Organizations

DAOs are communities governed by a set of rules encoded into smart contracts. Once these rules are established, DAOs use these contracts to enforce them, provide legal mechanisms for protection, and impose penalties for breaches. Essentially, DAO smart contracts function as the organization’s laws and “digital” bureaucracy.

Examples include governance protocols for Decentraland, Uniswap, Polkadot, and MakerDAO. In these projects, governance is managed by holders of the native tokens, who can propose changes (like adjusting fee structures, altering blockchain code, or adding/removing parachains) and vote on them. DAO contracts handle the voting process and count the votes.

Application Logic Contracts 

ALCs operate under a governing program and are primarily tasked with managing interactions between this program and the blockchain. For instance, ALCs might facilitate the integration of Internet of Things devices with blockchain.

Benefits of smart contracts

The advantages of using blockchain are impressive for individuals, businesses, and governments.

Transparency: One of the biggest perks is transparency. Every transaction on a blockchain is public and can be verified, so once data is added, it can’t be changed. This means you can trust that smart contracts are secure and haven’t been tampered with, giving you peace of mind whether using them personally or for business.

Cost efficiency: Smart contracts take care of a lot of the legwork when it comes to setting up and managing agreements. Since they don’t require intermediaries like lawyers, banks, or brokers, they save money and streamline processes.

Building trust: Because smart contracts are automated, they reduce the chance of human error and build trust between parties.

Secure storage and backup: Losing data is a big risk for any organization. While backups are important, they’re not always foolproof. Blockchain technology, however, keeps data across many nodes, so it’s much less likely to be lost or tampered with as long as the blockchain itself is running.

Security: Smart contracts are incredibly secure, thanks to advanced encryption and security protocols. They’re some of the safest tools for handling transactions today, offering strong protection against hacking and tampering — just like cryptos.

Use cases

Token smart contracts in cryptocurrency are used to create, manage, and assign ownership of specific digital tokens on blockchain networks. These contracts program the functionalities of the tokens they issue, giving them various roles.

For instance, they might enable tokens to serve as utility tokens for apps (offering features or benefits within an application), governance tokens that give holders voting power in a protocol, security tokens representing shares in a company, or NFTs that represent ownership of unique physical or digital assets.

Smart contracts examples

Examples of smart contracts in action:

Ethereum. Ethereum allows developers to build dapps and underpins many DeFi projects. Smart contracts on Ethereum are super flexible, handling everything from turning real-world assets into digital tokens to automating transactions. It’s a hub for a lot of groundbreaking blockchain activity.

Then there’s Binance Smart Chain. It’s celebrated for its speed and efficiency. While it’s compatible with Ethereum, it offers lower fees and better performance, making it a great choice for various projects. It’s become a popular choice for DeFi projects and tokenization due to these advantages.

Polkadot. Polkadot is all about connecting different blockchains. It lets you create parallel blockchains that can interact with each other and supports smart contracts for various applications, enhancing blockchain interoperability.

Chainlink. Chainlink is like a bridge that connects smart contracts to the real world by providing them with external data. Thanks to its decentralized oracles, these contracts can access real-time information, which makes them even more dynamic and adaptable.

Future of smart contracts

The future of smart contracts is bright and full of potential. As technology keeps evolving, these contracts are set to get smarter, safer, and more efficient. This is thanks to ongoing upgrades in blockchain tech and better programming tools.

We’re likely to see this technology contracts revolutionize industries beyond finance and legal sectors, influencing areas like supply chain management and government operations. All in all, smart contracts are gearing up to be a major force in shaping the future of our digital world.