Whether you're just getting into crypto, or are a seasoned "OG", chances are high you've come across the term "smart contract." Smart contracts play an incredibly important role in blockchain technology and crypto as a whole.
In this guide, we'll cover everything you need to know about what a smart contract is, and why smart contracts play a critical role in the further adoption of cryptocurrency.
What is a smart contract? An inside look at the blockchain technology
Smart contracts are simply code stored on the blockchain that run when certain conditions occur. In general, the code is open and transparent, and functions without the need of approval from any additional party. Smart contracts can automate and verify a wide variety of tasks and functions, and help "decentralize" everything from finance, and to insurance, and more.
Smart contracts were first proposed in the early 1990s by Nick Szabo, who coined the term and continued play an essential role in crypto today.
Essentially, you can write a protocol (smart contract) that'll execute an agreement or verify a piece of information without needing a third party like a lawyer or mediator.
By removing this third party, you actually increase levels of safety, security, and non-bias from an agreement; this is because smart contracts are trackable and irreversible and contain all of the information and terms of the agreement and execute all envisaged actions automatically. Smart contracts currently operate on every major blockchain network multiple different including Solana, Ethereum, and Cardano.
Smart contracts are important because they remove centralized middlemen in contexts that require trusted third parties to help facilitate value transfer.
How do smart contracts work?
Smart contracts are built from code that will automatically execute an order once the parameters of the agreement have been met. The terms of the contract are agreed upon by both parties involved in the transaction. Essentially, the smart contracts work exactly how they are coded. In theory, there are no secrets or exceptions.
Once the terms have been agreed upon, the instructions are then written into code. The code will consist of various conditional statements that will account for any possible scenario and how the smart contract should operate if this particular scenario happens.
The code is stored and passed around the blockchain network, with all computers of the network now able to execute the code.
6 benefits of smart contracts
1. Cost and time saver
By removing the middleman and large intermediaries from a process, you'll significantly reduce costs, and the transaction or process itself will become faster and more simplified over the long run.
Smart contracts can help reduce admin and labor costs, making transactions and processes cheaper and easier for people and businesses. Because smart contracts are fully automated and transparent, there's less need for 3rd parties to step in. An agreement made through a smart contract is set in stone. There is very little grey area.
When X occurs, Y will occur shortly thereafter.
2. Innovative security applications
In general, once you write the code of a smart contract, it cannot be tampered with; it will work in the way they are intended to and cannot be hijacked. The only issue is that you need to ensure that the code that you write is accurate with zero bugs.
Carrying out transactions between multiple parties doesn't require you to trust the other party because the smart contract code deterministically enforces the rules of the contract. You can imagine the applications for this.
For example, if your insurance policy is run through the blockchain, you can have a smart contract guarantee a certain amount of money if you were to get in a car accident.
Nonetheless, security is still a concern because the logic of a smart contract could be incorrect. This is why it is typical for smart contracts to be carefully audited by security experts before deployment onto the blockchain.
If the contract's logic is correct, then its code can execute trustlessly, and the results of any execution will be verifiable and immutable.
3. Transparency and Reliability
Thanks to smart contract technology, all transactions are stored on the blockchain. Therefore, every transaction made is completely transparent and can be verified.
No one can tamper with the data stored on the contract, which makes them more reliable than traditional paper or spreadsheet records.
Not only that, but both parties will work to write the smart contract, meaning that there will be no room for backtracking or not fulfilling their side of the agreement.
4. Safe storage
Smart contracts store vital data that in the event of a data loss on other systems, the data held on the smart contract can be retrieved as all information is permanently stored on a blockchain. Because many blockchains utilize computer networks from all around the world, there's no single point of failure. A fire in a massive server room for example, would not affect a blockchain network designed for global access.
5. Certainty of transaction
Smart contracts operate by code; if the pre-agreed criteria are met, the smart contract will execute with zero hesitation. There will be no chance whatsoever of fraud, hesitation, or backtracking.
Automation is most certainly the most significant advantage of using smart contracts. The contract executes on its own and with zero need for human intervention.
No other action is required once the code is written and terms are agreed upon. Businesses will be able to automate several aspects of their operation, resolve trust issues and reduce costs within business processes.
6 Smart contract use cases and examples
1. Travel Insurance
If you are going on vacation and take out flight insurance using a smart contract, and your flight got canceled, that contract could be executed to determine if your claim should be paid out.
Since your flight was canceled, and this is easy to prove, the smart contract would likely pay out your claim immediately.
Suppose you take out an insurance policy using a current-day insurance company. In that case, the insurance company would evaluate your claim and can decide whether or not to pay you or begin some sort of investigative process that consumes time and resources.
Insurance claims can take weeks and sometimes months to close; smart contracts can help reduce this typically lengthy and cumbersome process.
Another example of how smart contracts can be used in the real world is in the approval of mortgages. If you are a homeowner or broker, you know better than anyone that mortgages can take up to two months to approve. Parcl has written about crypto mortgages before.
Smart contracts can significantly reduce this time to just a few days if the person seeking the mortgage has all the relevant information and meets the parameters of a smart contract that writes mortgages.
By using smart contracts in the healthcare sector, you could store patients' health records on a private or hybrid blockchain. Smart contracts could help to scour millions of records to perform analysis of patient information to make a hospital more efficient or to ensure the smooth running of the internal supply chain.
If the health sector adopts technology such as health bracelets, it will register all of your information such as blood pressure and heart rate.
This vital information could then be communicated to healthcare professionals using a smart contract to provide a live data feed; if any of the health parameters cross, the relevant people can receive a notification.
The smart contract will notify you, your family, and a healthcare professional about your current state of health; it could even go as far as ordering your medication.
4. Supply chain management
Paper-based supply chain management can be a complete disaster.
The bureaucracy of gaining approval, and the tedious task of tracking, increase the chances of fraud, loss of materials, and costly mistakes. For example, HomeDepot currently uses blockchain technology to help resolve disputes with its vendors.
Smart contracts can help manage the inventory and automate payment and tasks. Warehouse managers will be able to see real-time stock levels and an accurate understanding of how long it'll take to restock.
This will, in turn, improve delivery times thanks to smart contract data that can be collected and analyzed. Clear records of when items are most popular will allow businesses to plan ahead, avoiding overstocking and tying up money in products they won't sell.
5. Digital identity
If you, for some reason, have to verify your identity or somewhat private details of your life to an institution, you can completely streamline the process by storing your job, bank, and demographic details on the blockchain.
And by using a smart contract, this information can be shared with any person or entity you wish; it can be pulled from the blockchain instantly. The KYC (know your customer) process will be instantaneous. A benefit of this is that you can control which information you share, meaning you're in control of your own information.
6. Get real estate exposure with Parcl Protocol
The Parcl Protocol uses multiple smart contracts across its synthetic real estate and token swapping protocols. Prices of Parcl assets – tokens that represent the price per square foot in a given geographic area–are determined using the Parcl protocol's property valuation database.
Traders use the Parcl Protocol AMM smart contract to trade Parcls of their favorite neighborhoods and cities. The contract custodies tokens and facilitates token swaps as opposed to a centralized trading company performing value transfer and custody.
Similarly, Parcl assets are created, or minted, when users deposit collateral into a vault against which they can mint pAssets. The contract ensures that a vault cannot mint more Parcl assets than it has collateral to back the pAssets according to a risk parameter set by the protocol.
The process of evaluating collateral and Parcl asset dollar values to assess the risk of minting new Parcl tokens is all handled via smart contract logic that underwrites and manages the risk as well as handles internal accounting of debts.
Smart contracts may have a ways to go before being used in by everyone in every day life, but the potential is going to transform the way we interact, do business, buy real estate, and more faster than most think.