What are smart contracts?

To understand what a smart contract is in the context of cryptocurrency, it’s important to note that it may initially appear similar to a digital version of a traditional agreement.

At its core, a smart contract is a program that automatically enforces the terms of an agreement between parties once predefined conditions are met. This means that when the predetermined parameters are satisfied, the smart contract executes the corresponding actions without requiring third-party intervention. This approach simplifies the transaction process and ensures security and transparency, as all actions are recorded on the blockchain and can be verified. As a result, smart contracts mitigate risks associated with human error and provide efficiency across various domains — ranging from financial transactions to asset management.

History of development

The concept of smart contracts was first proposed in 1994 by computer scientist and cryptographer Nick Szabo, even before the term itself existed. He defined them as computer protocols designed to automatically execute the terms of agreements and transactions. Szabo’s goal was to translate the real-world functions of traditional electronic payment systems into the digital realm.

He proposed using smart contracts to work with synthetic assets such as derivatives and bonds. Szabo writes that new securities can be created by combining financial instruments — options and futures. Implementation via smart contracts, he believes, will reduce transaction costs and simplify trading.

How smart contracts work

Smart contract technology operates based on «if/when…then…» rules, which can be written in code and deployed on a blockchain. This allows for the creation of detailed conditions under which specific actions are automatically triggered. When a set of conditions is met, the blockchain network of computers automatically executes the corresponding actions, such as transferring funds to parties, registering a vehicle, sending notifications, or issuing tickets.

Once the conditions are fulfilled, the transaction and the smart contract code become final, making any changes impossible. This ensures a high level of reliability and transparency, eliminating the possibility of manipulation or errors that might occur with manual management. In this way, smart contracts open up new opportunities for automating and optimizing business processes.

Configuring smart contracts on a blockchain allows for as many condition sets as participants need to feel confident in the execution of the agreement.

Transparency

Smart contracts operate on blockchain — a public and immutable technology. All data and transactions are recorded and accessible to network participants, eliminating the need for intermediaries or third parties. The technology itself ensures fairness in the fulfillment of conditions.

Automation

Automation removes the need for manual oversight of obligation fulfillment, reducing the likelihood of human error. The smart contract system accelerates the execution of transactions, avoiding delays often caused by human involvement in traditional contracts. Blockchain simplifies the process through its algorithms.

Reduced risks and costs

Under the principles of smart contracts, it is impossible to enter an agreement and then violate its terms, as the contract executes strictly according to prewritten rules. Any violation is immediately recorded on the blockchain, providing a level of security and transparency unattainable in traditional systems.

By eliminating the need for third-party involvement, participants can significantly reduce both risks associated with human factors and financial costs. This means parties can avoid additional fees often charged by intermediaries and sidestep delays caused by their involvement. This approach makes transactions faster, more cost-effective, and redefines the way parties interact.

Smart contracts are typically applied in the following industries:

• Financial Services (BFSI) and Cryptocurrency:
  Peer-to-peer (P2P) transactions, insurance claims processing, auditing, reducing operational costs, decentralized finance (DeFi) applications, and cryptocurrency operations.
• Healthcare: Managing patient data, conducting clinical trials and research, and tracking the lifecycle of pharmaceuticals.
• Logistics and Supply Chain: Tracking goods, verifying their origin, and ensuring compliance with regulatory standards. Trade groups are already using smart contracts in freight transportation.

Security Issues

At the current stage, any errors or vulnerabilities in the contract code can be exploited by malicious actors to manipulate the system or steal funds. Additionally, once a transaction is completed, its results cannot be altered. If a mistake occurs, it cannot be corrected.

Legal Challenges

Legal issues also arise, as in most countries smart contracts do not yet hold legal validity. This creates significant difficulties, particularly in cases of disputes between parties. A court may not recognize the automatic execution of obligations as enforceable.
To fully integrate smart contracts, appropriate legal frameworks must be developed. This includes defining the legal status of smart contracts, mechanisms for their enforcement, and the legal responsibilities of the parties involved.

Blockchain Limitations

Blockchain networks, particularly Ethereum, face scalability issues. High transaction volumes can slow down the network and increase fees. During peak load times, executing more than one or two transactions on Ethereum can become prohibitively expensive.

The application of smart contracts has long surpassed decentralized finance and is no longer confined to niche areas. In the future, smart contract technology will become even more integrated into everyday life, particularly through its connection with the Internet of Things (IoT). For instance, smart contracts could automate payments for services provided by IoT devices and manage supply chains by triggering contracts based on data collected from sensors and devices.

Moreover, the architecture of smart contracts could be combined with artificial intelligence (AI), enabling improved analytics and forecasting in various business processes. This symbiosis of technologies will provide more efficient solutions, allowing processes to be automated and optimized on a larger scale.

However, widespread adoption of smart contracts requires further advancements in legal frameworks and interoperability standards to enable seamless communication between different blockchains. This will create a foundation for the secure and reliable use of smart contracts across industries, which, in turn, will facilitate their broader adoption in everyday life.