What Does Smart Contract Mean?
A smart contract is a self-executing agreement in which the terms of the contract are written into lines of code. Smart contracts use distributed ledgers like blockchain to document and validate contract transactions in a secure, transparent manner without the need for oversight by a central authority.
One of the main advantages of smart contracts over traditional contracts is their ability to automate each step of a contract’s execution when predetermined if/then conditions are met. In business, smart contracts are used to:
- Automate financial transactions.
- Track the movement of goods and verify their authenticity and ownership at each step of a supply chain.
- Create and manage decentralized identity and access control systems.
- Verify ownership of a digital or physical asset.
- Support applications that run in a decentralized blockchain environment (DApps).
Techopedia Explains Smart Contract
The idea of smart contracts was first proposed by computer scientist and legal scholar Nick Szabo in the mid-1990s. Szabo envisioned a system in which contracts could be self-executing, using computer code to enforce the terms of the contract.
It wasn’t until Bitcoin and the widespread use of distributed ledger technology for cryptocurrencies, however, that the concept of smart contracts really started to catch people’s interest, especially in industries such as finance and supply chain management.
Here is an example of how a smart contract can be used in supply chain management (SCM):
- A supply chain manager asks their IT department to create a smart contract that documents the movement of a commodity from a supplier to the manager’s warehouse.
- Product developers use Solidity to write code that specifies the parties involved, the terms of the contract and the conditions under which the contract will execute.
- The smart contract is deployed on an Ethereum blockchain, and each party involved in the supply chain is given access to the contract’s address on the blockchain.
- As the commodity moves through the supply chain, the smart contract documents the transaction, verifies the information recorded on the blockchain, and ensures the conditions of the contract are being met.
- If the conditions are met, the smart contract executes the contract’s pre-defined if/then statements.
- If any of the conditions in the contract are not met, the smart contract triggers a predefined action, such as alerting relevant parties or preventing the commodity from moving forward in the supply chain.
- Once the commodity reaches the supply chain manager’s warehouse, the contract initiates payment to the supplier.
Advantages of Smart Contracts
By deploying a smart contract on a distributed ledger, all parties involved in the supply chain have access to a secure and tamper-proof record of the transaction that ensures the information is accurate, up-to-date, and transparent.
If at any time during contract execution, an involved party wants to check the status of the contract, they can use a client application or web interface to call a function on the contract that will return the data they are interested in. The function call gets broadcast to the network, and the requested data will be returned if the call is successful.
Challenges of Smart Contracts
One of the biggest challenges of using smart contracts in business is that there is still a lot of regulatory uncertainty around the use of smart contracts, especially in heavily regulated industries such as finance and healthcare.
While smart contracts are designed to be tamper-proof and secure, there is still the possibility of bugs or code vulnerabilities that could be exploited by malicious actors.
When there are concerns about how disputes or errors in smart contracts should be resolved, there can be confusion about whether different geopolitical regions should apply their traditional contract laws to smart contracts. In response, some jurisdictions in the United States have made efforts to provide new legal recognition for smart contracts with mixed results.
Smart Contracts and Cryptocurrencies
Smart contracts play a critical role in the management and transfer of cryptocurrencies. They are used to:
- Automate cryptocurrency payments.
- Facilitate flash loans and other types of peer-to-peer trading.
- Issue and manage blockchain tokens that represent some form of value.
- Create escrow services that ensure funds are only released when certain conditions are met.
Smart Contracts and DApps
A DApp is an application that runs on a distributed ledger. DApps use smart contracts to automate the execution and enforcement of the application’s rules and logic. For example, a DApp that enables peer-to-peer lending might use a smart contract to automatically transfer funds from a lender to a borrower based on predefined conditions, such as the receipt of collateral.
Smart Contract Distributed Ledgers
Although Ethereum is the most well-known and widely-used blockchain platform for smart contracts, it is not the only blockchain platform to support smart contracts.
Other popular distributed ledgers that support the creation and execution of smart contracts and DApps include:
- Binance Smart Chain
While all the platforms above support smart contracts, the specific functionalities each platform offers and the way contracts are implemented vary from platform to platform. For example, some blockchains, such as Ethereum and Binance Smart Chain, support multiple programming languages for smart contract development, while others, like Cardano and Tron use a specific language for smart contract development.
Smart Contract Service Vendors
It can be difficult to find developers who have the expertise to develop and implement smart contracts, so it’s no surprise that vendors are using an “as-a-service” delivery model for them. Some of the major vendors in the smart contract space include:
ScienceSoft – is known for helping clients integrate oracles with smart contracts. Oracles, in the context of smart contracts, are third-party services that feed off-chain data to the smart contract.
Innowise – is known for helping clients select the most appropriate blockchain platform for their smart contracts.
Avalanche – claims to be the fastest smart contracts platform in the blockchain industry, as measured by time-to-finality.
4soft – is known for helping clients optimize their smart contracts.
VeriDoc Sign – an e-signature service supported by smart contracts.
Smart Contract Security
While smart contracts executed on a distributed ledger offer many security benefits, there are still security risks associated with their use, including:
- Bugs and vulnerabilities: Smart contracts are written in code, and like any software, they can contain bugs and vulnerabilities that can be exploited by attackers to steal funds, disrupt the network or maliciously manipulate outcomes.
- Oracle attacks: Smart contracts often rely on external data sources (known as oracles) to execute certain functions. Once a third-party oracle has been compromised, it can be used to provide a smart contract with inaccurate data.
- Code execution vulnerabilities: Smart contracts are vulnerable to attacks that exploit mistakes in the way the code gets executed. For example, an attacker could exploit race conditions to conduct a reentrancy attack.
- Network-level attacks: Smart contracts are executed on a blockchain network and like any network, they can be subject to denial-of-service (DoS) attacks and other exploits designed to disrupt the network and compromise security.
To address these concerns, smart contract developers need to implement robust security measures, including code audits, multi-signature controls and regular security assessments. Increasingly, artificial intelligence (AI) and machine learning (ML) are being used to monitor the execution of smart contracts and trigger actions or alerts when predefined conditions are not met or when anomalies are detected in data patterns.