Demystifying Smart Contracts in Blockchain: A Beginner's Guide.

Summary

Smart contracts are an important innovation in blockchain technology that has the potential to transform many industries. This article is a beginner’s guide and has been written to break down and demystify smart contracts in blockchain for beginners.

Understanding smart contract basics helps readers evaluate how this technology can impact businesses and industries. Those interested in leveraging smart contracts should explore development platforms and sample projects to turn ideas into reality. Mastering smart contract creation can lead to valuable career opportunities. Take the Crypto Finance and Defi Masterclass at Vorem Academy to learn more.

Introduction to Smart Contracts

A smart contract is a self-executing contract written into lines of code that is stored on a blockchain. Smart contracts allow two parties to exchange money, property, shares, or other assets without requiring a middleman.

The concept of smart contracts was first proposed in the 1990s by computer scientist Nick Szabo. He defined a smart contract as “a set of promises, specified in digital form, including protocols within which the parties perform on these promises.”

The main capabilities and benefits of smart contracts include the following:

• Autonomy: Smart contracts operate automatically when conditions are met, reducing the need for intermediaries.
• Trust: Smart contracts are immutable once deployed on the blockchain, ensuring neither party can make changes without the other party’s consent.
• Backup: Smart contracts are duplicated across many nodes on a blockchain, providing built-in redundancy.
• Safety: Smart contracts can reduce the risk of errors, fraud, and exploitation through automation.
• Savings: Smart contracts save time and money by replacing intermediaries and legal costs.
• Accuracy: Smart contracts are accurate and avoid manual errors since they are digitally coded.
• Transparency: Smart contracts can be inspected by all parties on a blockchain before signing.

By enabling agreements to be trustlessly executed between two parties, smart contracts have the potential to revolutionize many industries.

How Smart Contracts Work

Smart contracts are self-executing programs that run on a blockchain. They are pieces of code that are stored on the blockchain and automatically execute when predetermined conditions are met.

Some key features of smart contracts include:

• Self-Executing Code: Smart contracts are made up of code that is stored and replicated on the blockchain. Once deployed, it will run automatically according to the instructions coded into it.
• Runs on Blockchain: Smart contracts leverage the inherent security and automation of blockchain technology. They run on top of a blockchain, which acts as a decentralized infrastructure.
• Triggers When Conditions Are Met: Smart contracts execute when predefined conditions are met. The transactions that trigger executions are recorded on the blockchain, enabling traceability and auditability.

Once a smart contract is created and deployed on the blockchain, no further actions or interventions are needed for execution. The parties involved just need to provide information or funds to meet the triggering conditions configured in the contract. This eliminates the need for middlemen and makes the execution process transparent.

Smart Contract Use Cases

Smart contracts have a wide range of use cases across many different industries, offering the potential to streamline processes and remove intermediaries. Here are some of the most promising use cases:

Financial Services

• Automated insurance payouts: Insurance claims can be automatically paid out when pre-defined conditions are met. This removes the need for manual review and approval of claims.
• Automated dividends: Shareholders can receive automatic dividend payments distributed based on pre-defined rules encoded in a smart contract.
• Crowdfunding: Smart contracts enable decentralized crowdfunding platforms to collect and release funds without an intermediary.
• Trade finance: Smart contracts can automate trade finance processes like letters of credit, escrow services, and payment collections.

Real Estate

• Property transactions: Smart contracts can encode the logic for tasks like property transfer and payment collection in real estate deals.
• Rentals: Smart contracts can automatically collect rental payments and transfer funds between tenants and landlords.
• Property registrations: Smart contracts can encode deeds and property titles and store them in a blockchain.

Supply Chain

• Payment collections: Smart contracts can facilitate instant, low-cost payment collection between supply chain entities on delivery.
• Tracking inventory: Smart contracts can record the quantity and movement of inventory through the supply chain on the blockchain.
• Quality control: Metrics like temperature and humidity can trigger automated smart contract payments or other actions.

Healthcare

• Managing records: Patient records can be encoded into smart contracts with rules controlling access permissions.
• Insurance claim processing: Smart contracts can automatically validate and pay out medical insurance claims.
• Drug supply monitoring: Smart contracts can track drugs through the supply chain from manufacture to delivery.

Government

• Voting: Smart contracts can enable transparent, verifiable, and secure voting on the blockchain.
• Welfare disbursement: Welfare aid can be distributed via smart contracts with blockchain-tracking fund allocation.
• Identity management: Citizens' identity information can be securely stored in smart contracts with self-sovereign identity models.
• Tax collection: Smart contract codes can trigger automated tax payments from entities to governments.

Developing Smart Contracts

Smart contracts are programs that run on a blockchain. Developing them requires some specialized skills compared to traditional application development. Here are some key aspects of smart contract development:

• Programming Languages: Most smart contracts are written in Solidity, a programming language similar to JavaScript that is designed for developing smart contracts on Ethereum. Other options, like Vyper and Bamboo, are also available. Learning Solidity, or another smart contract programming language, is essential.
• Testing and Auditing: Thoroughly testing smart contracts is critical since they often handle finances and you cannot easily patch vulnerabilities once deployed. Both manual testing and automated tools should be used. Formal verification and professional audits are recommended for large contracts that secure significant value.
• Deploying on the Blockchain: Once developed and tested, smart contracts get deployed to a blockchain like Ethereum. Deployment is done via specialized tools and often requires paying a network transaction fee called "gas.” Upgrades require careful planning to avoid disrupting apps relying on the smart contract.

Developing robust smart contracts takes practice and expertise. Leveraging development frameworks and following security best practices can help minimize vulnerabilities in this emerging field. With careful testing and auditing, smart contracts can securely automate business processes on the blockchain.

Smart Contract Platforms

Smart contracts are now supported by several leading blockchain networks. Some of the most popular platforms for developing and deploying smart contracts include:

Ethereum

Ethereum was the first blockchain to support smart contracts and remains the most popular platform. The Ethereum Virtual Machine (EVM) executes smart contract code, enabling developers to build decentralized applications (dApps) on Ethereum. Due to its first-mover advantage, Ethereum has the largest ecosystem of developers, applications, and institutional adoption.

However, Ethereum faces challenges with scalability and high transaction fees. The network is transitioning to a proof-of-stake consensus model and sharding, which aims to improve scalability.

Cardano

Cardano is a proof-of-stake blockchain that supports native smart contracts through the Plutus platform. It aims to be a more scalable and lower-cost alternative to Ethereum.

Cardano claims it will achieve better security through formal verification of smart contracts. This mathematical approach validates code correctness, which could reduce smart contract vulnerabilities and risks.

However, Cardano’s smart contract capabilities are relatively new, and its ecosystem lags behind Ethereum. It remains to be seen if it can rival Ethereum as the leading smart contract platform.

Solana

Solana prioritizes high scalability and fast transaction speeds, touting over 50,000 transactions per second. It takes a unique hybrid proof-of-stake and proof-of-history approach to achieve this performance.

Developers can build smart contracts on Solana using the Rust programming language. A key focus is on creating decentralized finance (DeFi) applications.

While an interesting newcomer, Solana is still relatively untested for enterprise smart contract adoption compared to Ethereum.

Polkadot

Polkadot offers a heterogeneous multi-chain architecture where customized blockchains can interconnect while still maintaining security.

Developers can build their dedicated smart contract blockchains using the Substrate framework. They can then connect it to the Polkadot relay chain and leverage shared security.

By spreading transactions across chains, Polkadot aims to solve scalability. However, the network is still in the mainnet, so real-world performance remains to be tested.

Near Protocol

NEAR Protocol is a newer smart contract platform that uses sharding to improve scalability. In early tests, it can process over 100,000 transactions per second.

The network utilizes Nightshade, a WebAssembly-based runtime for developing and deploying smart contracts. Coding smart contracts in Rust or AssemblyScript languages is meant to improve security.

As a next-generation competitor to Ethereum, Near Protocol will need to attract developer mindshare and prove real-world adoption if it aims to become a top platform.

Smart Contract Security

Smart contracts automatically execute when conditions are met. This powerful automation brings risks if the contracts have bugs or vulnerabilities that attackers can exploit. As decentralized applications built on blockchains grow in popularity, ensuring smart contract security is crucial.

Vulnerabilities and Risks

Smart contracts are susceptible to vulnerabilities that can lead to attacks and financial losses, including:

• Re-Entrancy Attacks: An attacker makes recursive calls to withdraw funds repeatedly before the smart contract can update its state.
• Integer Overflows/Underflows: Occurs when an operation reaches the max/min value of a numeric variable type. Attackers can manipulate such overflows.
• Sybil Attacks: Attackers create multiple fake identities to gain disproportionate influence over a system.
• Denial of Service: Attackers can tie up computational resources or memory and prevent the smart contract from functioning.
• Access Control Issues: Sensitive functionality may be accessible to unauthorized parties if access controls are improperly configured.

Best Practices

Some best practices to enhance smart contract security include:

• Rigorously document requirements before coding.
• Adopt a “fail early, fail loud” approach to catch bugs early.
• Use established frameworks like OpenZeppelin to reduce coding errors.
• Keep contracts simple and modular.
• Test gas costs and optimize accordingly.
• Perform extensive unit testing.
• Fuzz test using available tools like Echidna.
• Conduct peer reviews of the contract code.
• Use established auditing procedures.

Auditing and Formal Verification

Auditing smart contracts involves manually reviewing code for vulnerabilities, while formal verification uses mathematical proofs to check correctness.

Popular auditing firms like ConsenSys Diligence and Quantstamp perform manual reviews of logic and test contracts extensively. Formal verification tools like MythX can prove the correctness of contracts mathematically.

Both auditing and formal verification should be conducted before deploying contracts to live environments. Though expensive, they greatly reduce the risks of exploits and losses.

Smart Contract Use Cases

1. Supply Chain Management

Supply chain management is one of the most promising use cases for smart contracts in blockchain. Smart contracts can help automate and optimize supply chain processes by increasing transparency, efficiency, and trust between parties.

Here’s a detailed example of how smart contracts can be used in supply chain management:

A manufacturer is shipping goods to a retailer. The entire process, from order to delivery, can be executed and tracked using a smart contract.

• The retailer places a purchase order which is encoded in a smart contract. This triggers a payment in cryptocurrency from the retailer to the manufacturer.
• The smart contract tracks the shipment status on the blockchain. GPS data and status updates like “picked up” and “delivered” are recorded transparently for both parties to view.
• Once the shipment is delivered, the smart contract releases the cryptocurrency payment to the manufacturer automatically.
• If the shipment gets lost or damaged, the smart contract can refund the retailer based on data like location, temperature, etc.

Using a smart contract for supply chain management provides several benefits:

• Autonomous control of the process: Smart contracts enable supply chain steps to execute automatically based on predetermined conditions coded into the contract. There’s no need for middlemen or manual oversight.
• Improved transparency: All parties can continuously view data like shipment status, temperature, etc. stored on the blockchain ledger. This increases trust and accountability.
• Faster processing: Automated payments and data transfers through smart contracts enable faster order fulfillment and delivery.
• Cost savings: Streamlining supply chain processes reduces overhead costs associated with paperwork, manual labor, etc.

By leveraging smart contracts, supply chains can become faster, more transparent, and more efficient. This use case demonstrates the immense potential for smart contracts to optimize business processes.

2. Decentralized Finance (DeFi)

Decentralized finance (DeFi) applications are one of the most popular uses of smart contracts today. DeFi aims to recreate traditional financial services like lending, borrowing, and trading in a decentralized way, without intermediaries.

Here is an example of a DeFi use case built on Ethereum:

Aave is a decentralized lending and borrowing platform. It allows users to lend and borrow a variety of cryptocurrencies using smart contracts, with interest rates set algorithmically based on supply and demand.

Here’s how it works:

• Lenders deposit cryptocurrency into special smart contracts on Aave. This funds the lending pool.
• Borrowers can then use their cryptocurrency as collateral to take out a loan from these pools.
• The smart contracts automatically handle interest rates and repayments. Borrowers get their collateral back when they repay the loan.
• No bank or intermediary is required, it’s all handled transparently and automatically by the smart contracts.

Some key benefits of DeFi lending platforms like Aave include:

• Access to lending and borrowing without requiring a bank. Anyone globally can participate.
• Interest rates are set transparently based on algorithms rather than by intermediaries.
• Everything is handled automatically by smart contracts for efficiency.
• Increased accessibility — anyone with cryptocurrency can lend or borrow.

So in summary, DeFi smart contract platforms like Aave are allowing traditional financial services to be recreated in a decentralized, transparent, and global way, unlocking new opportunities in finance.

Future of Smart Contracts

Smart contracts have huge potential, but there are still challenges to overcome before mainstream adoption. Here are some key areas of future development:

Improving Security and Scalability

While blockchain technology provides a high level of security, smart contracts can still have vulnerabilities that lead to exploits. Ongoing research aims to develop more secure and bug-free smart contract programming languages and frameworks.

Scalability also needs improvement to support enterprise usage of smart contracts. Innovations like sharding, sidechains, and layer 2 solutions could allow smart contracts to process many more transactions per second.

Integration with IoT, AI, etc.

Connecting smart contracts with IoT sensors, AI algorithms, and big data analytics unlocks new possibilities. For example, an IoT sensor could trigger automated payments via a smart contract when goods are delivered. AI algorithms can provide external data to smart contracts.

Adoption by Governments and Enterprises

Many governments are piloting smart contracts for areas like digital identity, benefits distribution, land registries, and records management. Enterprises are also exploring use cases like automating supply chains and legal agreements.

Widespread adoption by governments and enterprises depends on overcoming technical limitations, as well as updating policies, regulations, and legal frameworks to support smart contracts. But the benefits could be profound in terms of efficiency, transparency, and trust.

Mainstreaming and Killer Apps

For smart contracts to enter the mainstream, simpler programming frameworks and easy-to-use applications will be needed. This could enable “killer apps” that provide user-friendly smart contract services to the average consumer. If technical barriers can be lowered, smart contracts have the potential to profoundly impact daily life.

Conclusion

Smart contracts are an important innovation in blockchain technology that has the potential to transform many industries. This beginner’s guide provides an introduction to how they work and their key benefits.

The key points covered included:

• Smart contracts are self-executing programs stored on the blockchain that run when predetermined conditions are met. They are immutable and transparent.
• They can automate processes and remove intermediaries, reducing costs and improving efficiency. Common use cases include payments, supply chains, real estate, healthcare, and more.
• Developing smart contracts requires programming languages like Solidity and Vyper. Leading platforms include Ethereum, Tron, Neo, EOS, and Hyperledger.
• Smart contracts enhance security by executing automatically based on code, but bugs can lead to vulnerabilities. Formal verification methods help ensure correctness.
• Real-world examples show smart contracts streamlining rental agreements, facilitating trade finance, securing supply chains, and more. The possibilities are vast.