What are Smart Contracts — A Comprehensive Guide

The concept of smart contracts was first proposed by Nick Szabo in 1994. Szabo, a computer scientist, legal scholar, and cryptographer, is credited with developing the idea of digital currency. In 1998, he created a digital currency called “Bit Gold,” nearly a decade before Bitcoin was introduced. Szabo’s paper became a blueprint for the future of blockchain and cryptocurrency. However, during Szabo’s time, the technology needed to implement these ideas was not available.

In 2008, a whitepaper by Satoshi Nakamoto introduced blockchain technology to the world. With advancements in software, hardware, and the growth of the internet, blockchain gained widespread adoption over the next decade. In 2015, the Ethereum blockchain introduced the first practical use of smart contracts. Today, Ethereum remains the most popular blockchain for enabling smart contracts.

What are Smart Contracts?

Smart contracts were created to facilitate the execution of digital agreements between two or more parties without the need for a third-party intermediary. They allow for the automation of processes, reducing costs and increasing efficiency. They also provide a secure and transparent way to execute agreements, ensuring that all parties involved are aware of their obligations.

How Do Smart Contracts Work?

As the term suggests, contracts are agreement between two parties that are binding and self-execute when terms of the contract are met. The code and the agreements contained therein exist across a distributed, decentralised blockchain network. The use of blockchain network to store smart contract is to ensure confidentiality, transparency, and trustless nature of the decentralised system.

It allows trusted transactions and agreements to be executed among different kind of, anonymous parties without the need for a central authority, legal system, or external enforcement mechanism. They rendered transactions are traceable, transparent, and irreversible.

Step by Step Working of Smart Contracts:

1. Agreement: The parties, developers, or organizations using smart contracts determine the details of the contract. It includes the criteria of agreement to be fulfilled, how it operates, and what outcome is generated.
2. Contract Creation: Unlike legal contracts, a smart contract is written in a programming language. Its verification is done through code and security testing. The participants in the transaction create smart contracts on their own or by involving smart contract developers.
3. Deployment: Once the smart contract is written in code, it is published on a preferred blockchain by the parties. The smart contracts are inserted into the data field of the exchange and uploaded on the blockchain. After verification, it gets active on the blockchain and cannot be changed afterward.
4. Monitoring: The smart contract code runs and tracks the blockchain or a 3rd party pre-defined source to discover the conditions or prompt for execution. In the occurrence of a trigger like payment, date, digital event, etc. it gets self-executed.
5. Execution on the trigger: As per the “If/when… then …” statement, the smart contract is executed. The conditions can be a single event/action or multiple events like crypto payment, transfer of ownership, sale of NFTs, etc.
6. Record Keeping: This step is what ensures that the transaction is recorded and verifiable in the future. The results are published on the blockchain. The blockchain verifies the event, logs the data on the chain, and stores the conclusion on the blockchain. Anyone can access this record in the future for verification or proof.

Types of Smart Contracts

The smart contracts are categorized into 3 classes: legal, DAOs, and logic. Let’s dive deep into each of these to understand them:

1. Legal Smart Contracts

The traditional contracts are written as per the governing law and enforced by a central authority. They are binding as per the legal structure: “If this then that”. These are not the same as the smart contracts that reside on the blockchain. But if legal contracts are combined with blockchain, they can offer great transparency, immutability, and verifiability among the two parties.

While in traditional contracts, involving parties do digital signatures. The Smart legal contracts will get executed autonomously and fulfilment of the conditions mentioned in the contract. It could include making a payment on insurance, or transferring ownership on certain date. In case either parties fail to comply, they may face legal challenges.

2. DAO: Decentralized Autonomous Organization

DAOs are groups of members that are governed by smart contracts, that provide voting rights to each member. DAOs are decentralised organisations who choose to govern themselves on. a blockchain to reach certain objective. In DAOs, there’s no CEO or president. Instead, there are smart contract written with consensus of members to manage the functions and funds in the organisation. ENS DAO and Maker DAO (organisation behind a stable cound) are such examples.

3. Decentralized Apps and Logic for Apps

Also known as Application Logic Contracts (ALCs), are app based contracts that might also support sync with multi-chain contracts. The enable integration between devices or multiple blockchains. In other words, these are contracts between applications (machines) and are not signed by humans or organisations.

12 Use Cases of Smart Contracts in Real World

They are used in a wide variety of applications, such as financial services, insurance, real estate, supply chain management, and healthcare. They can be used to automate processes, reduce costs, and increase efficiency. Smart contracts can also be used to create digital tokens that represent real-world assets, such as stocks, bonds, and other financial instruments.

1. Supply Chain Management

Smart contracts can be used to automate and streamline the supply chain process by automating the tracking and transfer of goods and services between different parties. For example, a smart contract could be used to automatically release payment to a supplier once a shipment of goods has been received and verified.

2. Real Estate

Smart contracts can be used to automate the process of buying and selling real estate by automating the transfer of ownership and payment. For example, a smart contract could be used to automatically transfer ownership of a property to the buyer once the purchase price has been paid in full.

3. DeFi: Decentralized Finance

Smart contracts can be used to automate financial transactions, such as loans, insurance, and derivatives. For example, a smart contract could be used to automatically trigger the release of a loan once the borrower has satisfied all of the terms and conditions of the loan agreement.

4. Healthcare

Smart contracts can be used to automate the exchange of healthcare-related data, such as medical records and claims processing. For example, a smart contract could be used to automatically process and pay out insurance claims once all of the necessary documentation has been provided.

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5. Identity Verification

Smart contracts can be used to automate the verification and authentication of identity information. For example, a smart contract could be used to verify the identity of an individual before allowing them access to a particular service or resource.

6. Voting

Smart contracts can be used to automate the voting process in elections or other decision-making processes. For example, a smart contract could be used to automatically count and tally votes and announce the winner once the voting period has ended.

7. Royalty Payment in Media

The royalty distribution to artists, actors, and entertainers across streaming platforms and OTT platforms is challenging. The royalty payments are not transparent, automated, and are heavily influenced by various external factors. Smart contracts can streamline royalty payments in media by writing the terms of payments and conditions into the code and store it on blockchain. Smart contracts can make royalty payments transparent and verifiable.

8. Storing Real World Assets into NFTs

The movable and transferable properties of digital goods can be imported into the real world’s immovable assets with the use of NFTs. An NFT (non-fungible token), is a uniquely identifiable and movable digital asset stored on a blockchain. NFT contracts can be altered to support royalties, land, homes, and other assets in the real world. In essence, smart contracts allow us to treat digital assets as physical assets with tangible values.

9. Data Marketplaces

Because of Artificial Intelligence, the value of high-quality specific datasets has tremendously increased. The rise of big data and large pools of diverse datasets and data streams from different sources can be made available for buying and selling online. The smart contracts can govern the validity of data, transactions, and ensure a seamless marketplace without human intervention.

10. Virtual Identity

The Internet has lead to creation of virtual identity of humans. We interact on social media, closed and open communities, and various platforms using our virtual identity. Our digital data and assets can be used to generate a unique digital identification card, which is unique, verifiable, owned by real person. The smart contracts can help verify the identity of real humans virtually without sharing sensitive and personal data.

These contracts can be used for financial assessment done during lending/borrowing, it can reduce discrimination from hiring processes, and can also be used to avail government services without revealing personal details to individuals who may misuse it.

11. Elections and Polling

Voting is an essential yet a complex process that needs complete transparency, trust, and verifiability. Be it public voting for elections or voting in smaller governing bodies in sports, corporates, or industries. Voting can be made possible in a secure online environment created using smart contracts and a blockchian. The encryption will protect the voter’s true identity and yet store it on an immutable and verifiable ledger. Online voting systems build using smart contracts can save time and make the process more efficient.

12. Legal Processes

Civil laws can be potentially coded into smart contracts to help legal industry. The legally binding contracts in businesses, civil laws, and social dealings can be made more permanent, automated, and trackable with the help of smart contracts. National govt. around the world are authorising the use of smart contracts for digital agreements.

Advantages and Limitations of Smart Contracts

Smart contracts are created to facilitate, verify, and enforce the negotiation or performance of a contract. Here are some advantages of smart contracts explained in detail with examples:

Advantages of Smart Contracts

1. Automation

These contracts are automated, which means they can execute themselves without any human intervention. For example, if a smart contract is set up to transfer a certain amount of money from one person to another on a specific date, it will automatically execute the transaction on the specified date without any manual intervention.

2. Trust

Smart contracts are based on blockchain technology, which means they are transparent and immutable. This makes them trustworthy and eliminates the need for intermediaries or third parties to verify the contract. For example, if a smart contract is set up to transfer a certain amount of money from one person to another in exchange for a product or service, the contract cannot be altered or tampered with, ensuring that both parties can trust the terms of the contract.

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3. Efficiency

They’re faster and more efficient than traditional contracts because they are automated and do not require manual processing. For example, if a smart contract is set up to transfer ownership of a property, it can be done in a matter of minutes rather than the days or weeks it would take to process a traditional contract.

4. Cost-Effective

It can save time and money by eliminating the need for intermediaries or third parties to verify and enforce the contract. For example, if a smart contract is set up to transfer ownership of a property, the cost of hiring a lawyer to draft and process a traditional contract can be eliminated.

5. Accuracy

They are more accurate than traditional contracts because they are based on predetermined rules and conditions that cannot be altered. For example, if a smart contract is set up to transfer ownership of a property, the terms of the contract cannot be changed or modified, ensuring that the transaction is accurate and fair for both parties.

Limitations of Smart Contracts

1. Complexity

Smart contracts can be complex to design and implement, especially for individuals or organizations without technical expertise. This can lead to errors or vulnerabilities in the contract that can compromise its effectiveness. For example, in 2017, a bug in a smart contract for an Ethereum-based decentralized autonomous organization (DAO) allowed hackers to steal millions of dollars worth of cryptocurrency.

2. Limited Functionality

Smart contracts are limited by the capabilities of the blockchain platform on which they are built. This means that they cannot perform tasks outside of the capabilities of the platform, such as accessing external data or interacting with non-blockchain systems.

3. Immutability

Once a smart contract is deployed on the blockchain, it is extremely difficult to modify or change. This can be problematic if errors are discovered in the contract or if the contract needs to be updated to reflect changes in the underlying business or legal environment.

4. Lack of legal recognition

In many jurisdictions, smart contracts are not yet legally recognized as binding agreements. This means that parties to a smart contract may not have the same legal protections as they would in a traditional contract.

5. Security concerns

They are vulnerable to security breaches and hacks, just like any other computer system. If a hacker is able to gain access to a smart contract, they could potentially alter the terms or steal assets contained within the contract.

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6. Scalability Issues

Smart contracts can be resource-intensive to execute, which can lead to scalability issues on the blockchain. This can result in slow transaction speeds and high fees for users.

7. Lack of Flexibility

They are designed to execute automatically based on predetermined conditions. This lack of flexibility can be problematic if the parties to the contract need to make changes or exceptions to the terms of the contract

Top Smart Contract Languages

1. Solidity

Solidity is a high-level, contract-oriented programming language for writing a smart contract. It is designed to be used for creating decentralized applications (dApps) and is the most popular language to write Ethereum smart contracts.

2. Vyper

Vyper is a Python-like language for writing contracts on the Ethereum blockchain. It is designed to be more secure and easier to read and audit than Solidity.

3. Rust

Rust programming language is gaining popularity for use in smart contracts due to its focus on safety and security. It is designed to be fast and efficient, and it includes features such as memory safety and data-race prevention.

4. Simplicity

Simplicity is a functional programming language for writing contracts on Ethereum. Pretty much like Rust, it is designed to be more secure and easier to audit than Solidity.

5. Move

Move is a domain-specific language for writing smart contracts on the Libra blockchain. It is designed to be easy to use and secure, and is optimized for writing distributed applications (dApps).

6. Go

Go is a programming language developed by Google that is gaining popularity for use in smart contracts due to its simplicity and efficiency. It is a compiled language that supports features such as concurrency and garbage collection.

How to Write a Smart Contract — Step by Step Guide (2024)

Here’s a step-by-step guide on how to create a smart contract, including code to help you understand the process.

Step 1: Choose a blockchain platform

Before you start creating a smart contract, you’ll need to choose a blockchain platform to use. There are several different platforms available, including Ethereum, Hyperledger Fabric, and EOS. Each platform has its own set of features and limitations, so you’ll need to choose the one that best fits your needs.

For example, if you choose the Ethereum platform, you’ll be able to use the Solidity programming language to write your smart contract. Here’s an example of how to specify the Solidity version and define a simple contract using the Ethereum platform:

pragma solidity ^0.6.0;

contract SimpleContract {
  // Define variables
  uint public balance;

  // Define constructor function
  constructor() public {
    balance = 0;
  }

  // Define function to add to balance
  function addToBalance(uint _amount) public {
    balance += _amount;
  }
}

Step 2: Learn a programming language

To create a smart contract, you’ll need to know how to write code. The most common language for writing smart contracts is Solidity, which is used on the Ethereum platform.

However, other languages like Go and Rust are also used on other platforms. If you’re new to programming, you may want to start by learning the basics of a programming language like Python or JavaScript before moving on to Solidity or another language specifically for smart contracts.

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Step 3: Define the terms of the contract

Before you start writing code, you’ll need to clearly define the terms of the contract. This includes specifying the parties involved, the goods or services being exchanged, and any conditions or clauses that need to be met. It’s important to be as specific as possible to ensure that the contract can be accurately enforced by the code.

For example, if you are writing a simple contract to buy and sell a product, you might define the following variables and functions:

// SPDX-License-Identifier: UNLICENSED
pragma solidity ^0.8.24;

contract ProductContract {
  // Define variables
  uint public price;
  uint public quantity;
  address payable public seller;
  address payable public buyer;
  bool public contractClosed;

  // Define constructor function
  constructor(uint _price, uint _quantity, address payable _seller) public {
    price = _price;
    quantity = _quantity;
    seller = _seller;
    contractClosed = false;
  }

  // Define function to buy product
  function buyProduct(uint _quantity) public payable {
    require(!contractClosed, "Contract is closed");
    require(_quantity <= quantity, "Not enough product available");
    require(msg.value == _quantity * price, "Incorrect payment amount");
    buyer = payable(msg.sender);
    quantity -= _quantity;
    seller.transfer(msg.value);
    if (quantity == 0)
    contractClosed = true;
}

// Define function to cancel contract
function cancelContract() public {
require(!contractClosed, "Contract is already closed");
require(msg.sender == seller || msg.sender == buyer, "Only seller or buyer can cancel contract");
contractClosed = true;
}
}

Step 4: Write the code

Now it’s time to start writing code to create a smart contract. You’ll need to use the programming language you chose in step 2 to define the terms of the contract and specify the actions that should be taken when certain conditions are met. You may want to use code snippets or examples from other smart contracts as a reference.

For example, in the ProductContract example above, the `buyProduct` function includes several `require` statements to ensure that certain conditions are met before the transaction can be completed. The `require` statements check that the contract is not closed, that there is enough product available to buy, and that the correct payment amount has been received. If any of these conditions are not met, the transaction will be rejected and an error message will be displayed.

Step 5: Test the smart contract execution

Before deploying the contract, it’s important to thoroughly test it to ensure that it works as intended. This may involve running simulations or setting up a test environment to see how the contract behaves under different conditions. For example, you might create a test script that sends transactions to the contract with different input values to see how it responds.

You can use tools like Ganache to help you test your contract.

Step 6: Deploy the smart contract

Once you’ve tested the contract and are confident that it works as intended, you can deploy it to the blockchain. This will make it live and enforceable on the network.

To deploy the contract, you’ll need to use a tool like Hardhat or Remix to compile and deploy the code to the blockchain. You’ll need to have a wallet or account on the blockchain platform you are using, and you may need to pay a small fee to deploy the contract.

Overall, writing contracts can be a complex process, but with a little programming knowledge and some careful planning, you can create a smart contract that is secure, transparent, and enforceable.

Best Practices For Developers Writing Smart Contracts

Here are a few best practices developers should keep in mind when working on smart contracts:

1. Regular Updates

Regularly upgrading to newer versions, conducting security checks, and testing them for errors and edge cases is important. Since there’s no human intervention, it is essential to update and test them in an interval. It allows developers to identify vulnerabilities and potential errors.

2. Ensure Simplicity

Agreements that use smart contracts for added values of blockchains should aim at keeping them simple understand and debug. Complex logic in the contract can result in unexpected errors. Use pre-written code for smart contract for standard practices and results.

3. Write Test Cases

Test cases allow you to save time on detecting bugs and malfunction before it leads to failure in the system. Always test the smart contracts on testnet before deploying them on the mainnet of blockchain. Since it is difficult to fix and re-deploy smart contracts once they go live on a blockchain network, rigorous testing can’t be ignored.

4. Request Review from others

A fault or loophole in smart contracts can lead to missing funds or loss of digital assets. That’s why getting a through review from peers is a great way to ensure that your code does the expected. The developer community in web3 is strong, you can request the community for a review and suggest changes if needed.

5. Check Compiler Versions

Developers often miss out on declaring the compiler version in the contract codes. If you explicitly mention the compiler version in your code, you can avoid authentication and release challenges and ensure they it works across environments.

Key Takeaways

• Smart Contracts are digital equivalent of an agreement which is signed and stored on decentralised network called Blockchains. These contracts are written in code and get automatically executed when the terms and conditions of the contract are met. The smart contracts are written in blockchain specific programming languages like Solidity, Move, etc.
• Smart Contracts are computer protocols that facilitates, verifies, or enforces the negotiation or performance of a contract. From NFTs to Dapps and metaverse, digital contracts form the backbone of Web3.
• Smart contracts allow the performance of credible transactions without third parties. These transactions are trackable and irreversible. In this article, we’ll learn about smart contracts, how they work, types, benefits, limitations, tools, and use cases.

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