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What are Smart Contracts?

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16.08.2023
5min.
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What Is Smart Contract

A smart contract is a code on the blockchain that automatically triggers an action when certain conditions are met. You must have heard a lot about them, have an idea about the principles of their work, and you know that it was smart contracts that made the Ethereum blockchain so popular at the time. This article will help to systematize and deepen this knowledge. Let's start simple: what is smart contract in simple words and where it’s applied. Then, we will move on to more complex topics like how to write and read a smart contract.

How does smart contract work

A smart contract is a program code on the blockchain that allows you to automate processes. Let's say you want to settle your affairs (sorry, the example is gloomy, but this way, you will definitely remember it). How it works in today's bureaucratic reality:

  • You ask a lawyer to make a will.
  • The heir receives a paper document on the right to inherit.
  • In the event of your death, the heir with this document must apply to the notary in your country in order to initiate the transfer of property.
  • The notary enters data into the register.
  • The heir receives a paper document on the right to own property.

These are just basic steps. Inheritance law is different from state to state, from country to country, which makes it even more complex.

The process may also be interrupted for various reasons: the loss of a document, the inability to personally appear at an appointment with a notary, contesting the transfer of property in court by other potential heirs, and so on. In general, everything is very difficult, isn’t it?

How could it work on a smart contract?

  • You write a code in which you indicate that in the event of death, funds (in the form of tokens) or property (in the form of NFTs) are transferred to the heir’s cryptocurrency wallet.
  • In the event of your death, the contract automatically finds an entry in the registry and makes a transaction.

Thus, the chain of actions would work automatically without intermediaries and bureaucracy.

What is the problem solved by smart contract

In short, smart contracts are needed to make our lives easier. This is an opportunity to automate processes that would take much longer without smart contracts.

We have already covered one example of solving problems with a smart contract. Unfortunately, today they are rarely used in jurisprudence, since blockchain and bureaucracy are difficult to fit together. But in other areas, smart contracts are used very successfully (including by the largest companies).

Today, this technology is widely used in the insurance market. For example, if you bought flight cancellation insurance, you can automatically receive a payout when this condition is met. Also, blockchain contracts are used in betting: if the conditions on which the bet was placed are met, the smart contract automatically creates a request for the payment of winnings.

In the third quarter of 2022, 48,689 verified smart contracts were published, up 143% from 20,040 in the third quarter of 2021.

Most often, smart contracts are used, of course, in the crypto market. For example:

  • Decentralized finance (DeFi)
  • Stablecoin management
  • Staking and farming
  • Futures and options
  • Bots for automated trading
  • Credit default swaps
  • Play-to-earn games
  • Decentralized marketplaces
  • DEXs

In decentralized exchanges, by the way, smart contracts are generally the core technology.

DEX smart contract

One of the main applications of smart contracts is decentralized exchanges, one of which is WhiteSwap. There are three different types of DEX: Order Book, Automated Market Makers, and DEX Aggregators. They have different mechanics, but they all use blockchain contracts. Thus, DEXs, unlike CEXs, don’t store user funds, but only provide a tool for their automatic distribution. Cryptocurrencies and tokens circulate between users' wallets without intermediaries, and smart contracts make that possible.

So, what is smart contract on DEX blockchain, and how does it work?

  • You create a token swap request (for example, exchange 1 ETH for 1000 USDT).
  • The server checks for liquidity on the selected pair. Without a pool of liquidity, a trade would have to wait for a buyer who wants to buy 1 ETH for 1000 USDT exactly at the same time.
  • If there is enough liquidity, you send 1 ETH + transaction fee to the blockchain.
  • The transaction is queued for processing.
  • The contract sends 1000 USDT from the liquidity pool to your wallet.

DEX involvement is minimal here. Operations happen automatically, transactions are confirmed by miners or stakers.

Types of smart contracts

There are three types of smart contracts. Each is used to achieve different goals.

Smart Legal Contracts

These contracts are legally enforceable, and if somebody breaks them, there may be strict legal action against them.

However, it’s difficult to oblige someone to comply legally. The technology itself is not banned in any country in the world, including even countries that are unfriendly to cryptocurrencies, like China. However, in most countries, smart contracts are not binding. So, Smart Legal Contracts only make sense in those countries that officially admit smart contracts (for example, India).

DAO

Decentralized Autonomous Organizations are blockchain communities that interact with the code of a decentralized app. This way, technology makes it easier to manage a project fairly. By the way, WhiteSwap also uses it.

Application Logic Contracts

These contracts contain an application-based code that remains in sync with other blockchain contracts. It enables communication across different devices, such as the merger of the Internet of Things with blockchain technology.

How to write a smart contract

What is a smart contract? In fact, this is computer code, and technical knowledge is required to write it. An ordinary person cannot cope with this task. A developer who knows the programming language Python, Pascal, JS or Haskel can learn how to create smart contracts. The program reads the "terms of the contract" in these languages and translates them into bytecode, so the code weighs less and works faster. Experienced developers can write smart contracts right away as bytecode on Michelson.

In terms of blockchain choice, smart contracts support Ethereum, EOS, BSC, Stellar, Cardano, NEO, and Tron (as well as other less popular networks). Ethereum is the most widely used.

To be fair, there are services for writing zero-code contracts. For example, Bunzz or Thirdweb. However, no constructor can be compared with a professional developer, you know.

A contract often needs the help of third-party programs to work correctly. These programs are called oracles. They link the blockchain and the rest of the Internet (off-chain). Without them, the scope of smart contracts would be very narrow.

There are two types of oracles: incoming and outgoing. Incoming oracles collect data from the off-chain and transfer it to the blockchain. Let's go back to the insurance company example. The oracle can find information about the flight cancellation among open data and transfer it to the blockchain for insurance payment. The outgoing oracle, on the contrary, transfers data from the blockchain to the off-chain. For example, this can be used in a hotel. If the booking conditions are met, the outgoing smart contract oracle can activate the smart key card.

How to read smart contracts

The big disadvantage of smart contracts is that they are difficult for most users to understand. If even paper contracts often become a tool for scammers, then imagine how risky smart contracts can be. To protect yourself, it’s important to be able to read smart contracts.

The good news is that you don't need to have coding skills to do this. Well, it would be nice to have them, but it's not required. You can view basic contract information through Etherscan (for Ethereum contracts) or Solana Explorer (for Solana). To achieve this, you need to copy the address of the contract and paste it into explorer. There you can see information about the contract.

  • Contract Identity: fundamentals of the protocol.
  • Token details: learn more about the native contract token.
  • Transaction history: check how many transactions were made and for what period of time.
  • Code: view the source code if you can read it.

How to read a smart contract is a topic for a large guide. If you need detailed step-by-step instructions, we advise you to use the guide from Ledger: How to Read Smart Contract Data (author: Mohammad Musharraf).

Benefits of smart contract

Smart contracts are needed to automate processes, but is blockchain really required for this? After all, even without them, we see automation everywhere, anytime. For example, suppose you have a subscription to Netflix or Spotify. When a certain condition is met (the expiration of the previous subscription), a transaction is automatically completed (funds are debited from the bank account, and the subscription is renewed). And everything works without any blockchains!

What is a smart contract? That’s right, it’s an automation tool. But not only! However, they have a number of advantages over other programs.

Such a contract cannot be changed. None of the parties and no third parties have access to edit the contract, so it cannot be faked. If the parties want to change the terms, a new contract must be concluded.

The security of smart contracts is close to absolute because they are protected by the blockchain. They are almost impossible to hack. This is much better than a conventional electronic contract and many times better than a paper one. The terms of a blockchain contract cannot be violated, as the blockchain fulfills them automatically.

Finally, a blockchain contract cannot be lost. An electronic contract can be deleted from a device or a cloud, a paper contract can be lost, and a smart contract will forever remain publicly available on the blockchain.

Why are smart contracts important: conclusion

Summing up, smart contracts are a very cool and useful thing that has not yet realized even a tenth of its potential. They are critical for the financial market, blockchain, the Internet of Things (IoT) and much more. After all, if this technology didn't exist, there wouldn't be WhiteSwap.

What is smart contract’s future? To date, their usage is limited by the regulation of the crypto market, the lack of flexibility in legislation and distrust of new technologies. But we can't resist progress for too long! Sooner or later, smart contracts will go beyond the crypto market and become part of our daily lives.

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