Smart contracts or smart contracts in the Ethereum Blockchain, what are they? - Guide 2024

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The blockchain was born with bitcoin, allowing secure electronic payments at any time, in any place and without the need for intermediaries. But the potential of the blockchain does not lie in its financial function, but in the possibility of executing smart contracts, or in Spanish, smart contracts, as Ethereum made us discover.

The blockchain is not perfect, but it is gaining ground in the sector as the best alternative as a data management system, gradually supplanting traditional servers and cloud applications. The blockchain is a secure, fast and cheaper option, which is why banks and governments are turning to it.

Want to know what role smart contracts play in all of this? Don't miss this course on smart contracts!

What is a smart contract?

Smart contracts, also known as self-executing contracts, blockchain contracts, digital contracts, or smart contracts, are applications that run on the blockchain and perform certain actions such as exchanging money, properties, shares, or any type of information.

The importance of smart contracts lies in their use of the blockchain. By using the blockchain, these transactions are carried out in a transparent, conflict-free, and decentralized manner, that is, without intermediaries.

An easy way to understand the definition of smart contracts is to compare this technology to a vending machine. Normally, when you need to carry out an important transaction, you would go to a lawyer or a notary, pay them (a lot), and wait while they obtain the document (which can take a long time).

With digital contract technology, all you have to do is use the vending machine (with a cryptocurrency, in this case), and your document, driver's license, or whatever you want to acquire, would be yours.

In other words, they are blockchain applications that have all the rules of an agreement defined, just like a traditional contract does. The advantage of a smart contract is that it is automatically fulfilled, without the possibility of deception or manipulation, and without fine print.

What is an Ethereum smart contract

Digital contracts became popular with the arrival of a cryptocurrency: Ethereum.

According to Vitalik Buterin, the creator of Ethereum, the meaning of smart contract is:

(...) a program that executes a code (the contract's code) and automatically validates a condition. This automatically determines whether an asset should go to one person or back to the other person, or whether it should be immediately refunded to the person who sent it or some combination thereof."

Example of smart contract:

Suppose someone rents an apartment. Currently, this can be done through the blockchain by paying in cryptocurrencies. Every month, the landlord would send the rent receipt to the virtual contract shared with the tenant. At the same time, the tenant, on an agreed date, must transfer the payment to the account specified in the contract.

The digital contract, thanks to the blockchain, would resolve any conflicts that arise. If the receipt doesn't arrive, the tenant could receive a refund. If the tenant doesn't pay, the contract could be terminated or an guarantee could be executed. In addition, the contract could be automatically canceled.

In a more technological world, what the tenant would receive is a key that gives them access to the apartment. This key would automatically change every month and if they didn't pay, they wouldn't receive it and the owner could execute the guarantee. If the key wasn't transferred, the tenant could receive automatic compensation.

By using the blockchain, no one can alter the terms of the contract. Everything would be resolved instantaneously and flawlessly.

» Related article: Don't know how blockchain works to provide so much security? Visit our section on Blockchain.

A smart contract system can be used for all kinds of situations. From financial derivatives to insurance premiums, breach of contract, property laws, credit enforcement, financial services, legal processes, or crowdfunding agreements.

A real example of a smart contract in Ethereum

Below, we show you the actual code of a basic smart contract that was written on the Ethereum blockchain. Ethereum is the first and most popular cryptocurrency platform for coding smart contracts.

Lately, there have been many cryptocurrencies with certain advantages and fewer limitations for executing these contracts. Some of them are NEO, EOS, TRON, or Cardano.

» Related article: Discover the advantages and disadvantages of the most important cryptocurrencies in this cryptocurrency comparison.

Source: https://www.ethereum.org/token

Explanation of the smart contract. This contract stipulates that the creator of the contract will receive 10,000 BTC (bitcoins). In other words, this contract allows anyone with enough balance to distribute these bitcoins to other users.

How Smart Contracts Work

Smart contracts are agreements reached between two people. The terms and conditions of the smart contract are recorded in code that is created in the blockchain and that gets executed no matter what.

In exchange for the work carried out by the blockchain, payment must be made for the services provided, in this case with cryptocurrencies.

In short, it is paying for a program that processes a code on the blockchain for you. At first glance, you might think it's the same as a cloud service, but the reality is that smart contracts have certain additional advantages.

On the one hand, their usefulness goes beyond the traditional one, because they combine traditional cloud services, such as servers or databases, with document management services, such asautomatic signature and execution of documents.

Furthermore, it is a decentralized service that eliminates intermediaries. In other words, you can digitally manage documents without Microsoft or Google controlling your data and without the need to hire any law firm.

Another advantage over traditional contracts is that they are more cost-effective. Although it is true that you have to pay, it is a much cheaper service than that of a lawyer or a notary.

Types of smart contracts

To better understand how smart contracts work with blockchain, it is ideal to see what some of their uses are.

The truth is that their uses are practically endless, since smart contracts serve for a multitude of functions. From financial services to healthcare or insurance. Below we show you some of these uses of smart contracts:

Government Uses

Our politicians claim that it is extremely difficult for our voting system to be rigged and politicians never lie, do they? Smart contracts would dispel all concerns by providing an infinitely more secure system.

To manipulate a single vote, the entire blockchain would have to be decoded and changed. This would require excessive computing power. No one has that much computing power, not even Google or Facebook servers.

Furthermore, smart contract technology could increase low voter turnout. Much of the inertia comes from a cumbersome system that involves queuing, showing your identity, and putting a ballot in an envelope. With smart contracts, voters can transfer their votes online while maintaining their anonymity.

For example, the Santander Bank used blockchain for the voting of its General Shareholders' Meeting in 2018.

Information Management

The blockchain not only provides security, but also avoids possible communication problems and workflow due to its accuracy, transparency, and automated system.

Usually, business operations have to deal with a back-and-forth of information, waiting for approvals and for internal or external issues to resolve themselves.

A blockchain digital contract would streamline all of this. It also eliminates discrepancies that normally occur with data processing, which can lead to costly litigation and delays in settlement.

Financial services

In 2015, the Depository Trust & Clearing Corp. (DTCC) used a blockchain smart contract to process 345 million transactions. This involved moving over 1.5 billion dollars in shares.

Another example is Barclays bank, which uses smart contracts to record changes of ownership for its clients and automatically transfer payments to other financial institutions.

Transport logistics

According to Jeff Garzik, one of bitcoin's most notable developers, "UPS could execute contracts that say: If I receive cash at one location, then a product or package will be sent to that same location".

Too often, supply chains are hindered by paper-based systems, where forms have to go through numerous approval channels, increasing exposure to losses and fraud. The blockchain eliminates this by providing a secure and accessible digital version to all parties involved and automating tasks and payments.

Another company that has started using the blockchain for logistics management is Maersk, the world's largest container shipping company.

Cars

There is no doubt that we are progressing from lazy pre-human vertebrates to super-smart robots. Think of a future where everything is automated. Google is getting there with smartphones, smart glasses and even smart cars. That's where smart contracts (and blockchain) come in.

An example is that of autonomous vehicles, where smart contracts can use a kind of "oracle" that can detect who is at fault in a crash; the sensor or the driver, as well as countless other variables.

Using smart contracts, an auto insurance company could charge fees differently depending on where and under what conditions customers are driving their vehicles.

Characteristics of smart contracts

Among the properties of smart contracts, we can find the following:

  • Autonomy - You are the one who makes the agreement; there is no need to rely on a broker, lawyer, or other intermediaries to confirm it. By the way, this also eliminates the danger of manipulation by a third party, as the execution is automatically managed by the network, instead of by one or more individuals, who may be biased and make mistakes.
  • Trust - Your documents are encrypted in a shared ledger on the blockchain. There is no way someone can claim that they lost it.
  • Backup - Imagine if your bank loses your savings account. In the chain, all of your friends (the other nodes in the network) have your back. Their documents are duplicated multiple times.
  • Security - Cryptography keeps your documents secure. There is no hacking. In fact, it would take an unusually intelligent hacker and a computer with non-existent power to decrypt and modify the code.
  • Speed - Normally, you would have to spend a lot of time and paperwork on manually processing documents. Digital contracts use software code to automate tasks, thus reducing the hours of many business processes.
  • Savings - Smart contracts save you money by eliminating the presence of an intermediary. For example, you wouldn't have to pay a notary to verify the conditions of a mortgage.
  • Precision - Automated contracts are not only faster and cheaper, but they also avoid errors that occur when manually filling out stacks of forms.

Risks and problems of smart contracts

The technology of smart contracts is far from perfect.

What if the code has an error? How should Governments regulate these contracts? What will be the legal analysis of the smart contracts? Or, how would Governments tax these smart contract transactions?

For example, do you remember the rental example?

What if the tenant uses the apartment illegally or rents it out without the owner's consent? If this were a traditional contract, it could be terminated in court, but the blockchain is a different situation. The contract functions, no matter what happens.

The list of challenges is endless. Experts are trying to unravel them, but these critical issues are delaying their implementation.

Future of Smart Contracts

When talking about smart contracts, it seems like science fiction. But nothing could be further from the truth.

Part of the future of digital contracts lies in solving these issues. There are many companies that are focusing on this. For example, at Cornell Tech, they insist that smart contracts will become part of our daily lives and they are developing smart contracts for the legal sector.

So, do smart contracts mean the end of lawyers? Not at all, but they will probably have to adapt.

As experts in law, they will need to oversee and even create the smart contracts. In that case, lawyers will transition from writing traditional contracts to producing standardized templates for digital contracts.

Other industries such as commerce companies, credit companies, or accountants, can also use smart contracts with blockchain for tasks such as real-time audits and risk assessments.

Where can smart contracts be processed

Smart contracts are not a mature technology and are still under development. In their initial phase, they were closely related to the world of cryptocurrencies, so the most advanced smart contract platforms are associated with this industry. Some of the environments where it is possible to manage smart contracts are:

  • Bitcoin: Bitcoin is ideal for processing financial transactions, but has a limited capacity for processing documents.
  • Side chains: It is a platform for smart contracts with bitcoin that is slightly more advanced. Side Chain is another name for blockchains that run adjacent to Bitcoin and offer more space to process contracts.
  • NXT: NXT is a public blockchain platform that contains a limited selection of templates for smart contracts. It is limited and you can only use the templates, you cannot code your own.
  • Ethereum: Ethereum is another platform for smart contracts and the most advanced for coding and processing. You can code whatever you want, but you have to pay for the computing power used by computers to settle the contract with tokens or ether. Currently, several competitors have emerged, such as TRON, NEO or Cardano, that improve certain deficiencies that smart contracts had with Ethereum.
  • The potential of smart contract systems is infinite and can impact numerous industries, from healthcare and automobiles to real estate and law. Every day new functionalities are created for smart contracts.

    To conclude, we recommend the following video, which explains the concept of smart contract.

    Perhaps a video about smart contracts can help you understand it better?

    Did you find digital contracts interesting? Learn much more in our Ethereum tutorial.