Smart Contracts: What They Are and How to Use Them

The term smart contracts is one of the most well-known in cryptocurrencies. This tool is often seen as a technological revolution, the solution to many problems. Several companies are seeking to understand this new technology and use it to create systems that can completely change our world.

But what are smart contracts really? How do they work? To understand all this, we first need to know more about the blockchain and how smart contracts are inserted into it. And in today’s text, we will see everything about the relationship between Bitcoin, Ethereum, blockchain and smart contracts.

What are smart contracts?

Smart contracts are also known as smart contracts or digital contracts. They are contracts executed through codes written and operated on a blockchain. Therefore, smart contracts do not depend on any type of human intervention – in fact, they exist precisely to eliminate the human factor from contracts.

The idea behind smart contracts is to conduct transactions between two or more parties in a way that only those parties have access to the contract. This way, there is no need for lawyers, judges, or other intermediaries to enforce the execution clauses. Both the language and the clauses of the contract are as clear as possible.

In this way, smart contracts make the code itself their legal system. This principle is anchored in the phrase code is the law (the code is the law, in literal translation). According to this concept, contracts are executed, judged and fulfilled through previously written clauses.

How did smart contracts come about?

The idea behind smart contracts emerged in the 1990s, more specifically in 1997. That was when lawyer and cryptographer Nick Szabo wrote an article entitled The Idea of ​​Smart Contractsor “The Idea of ​​Smart Contracts”. Szabo, therefore, started this idea almost 20 years before the emergence of Ethereum.

In the first few lines, Szabo made it clear what he saw in smart contracts. The premise was to make it as difficult as possible to break contracts, making them more secure. For him, “many types of contractual clauses can be embedded in the hardware and software we live with.”

This would make contracts safer, cheaper, and easier to produce. At the same time, digitalization would be “a way to make breaking a contract expensive (and sometimes prohibitively expensive, if desired) for the offender.” A famous example of the application of a smart contract was a vending machine.

According to Szabo, the protection of these machines is a kind of smart contract. It is a contract with the bearer, as anyone with coins can participate in an exchange with the vendor. “The vault and other security mechanisms protect the stored coins and products from fraudsters, sufficiently to allow profitable deployment of vending machines in a wide variety of areas,” Szabo said.

Bitcoin

Although Szabo created a revolutionary concept, he never managed to implement it in practice. He even tried to implement it with BitGold, a cryptocurrency created in the 1990s, but it was unsuccessful. Thus, the contracts existed only in theory for almost 10 years.

When Bitcoin was created in 2009, Szabo’s ideas finally came to fruition. In fact, the creation of Bitcoin itself was the first successfully implemented smart contract. In addition, the Bitcoin blockchain provided the first functional framework for executing other types of contracts.

Szabo’s inspiration is clear, as the programmer was cited as one of Satoshi Nakamoto’s references in the white paper. However, Bitcoin had serious limitations in this regard, as the smart contracts supported by the network were very basic. Bitcoin itself had as its main feature the mere transfer of value, but the network did not have the structure to execute more complex contracts.

Ethereum

This limitation of Bitcoin caught the attention of Russian-Canadian programmer Vitalik Buterin. He wanted a network in which more sophisticated contracts would be possible for any situation. And it was with this idea in mind that in 2013 he announced the creation of Ethereum, a blockchain network that was officially launched in 2015.

In addition to cryptocurrency, Ethereum has made it possible to create other cryptocurrencies and blockchains within its own network. And unlike Bitcoin, on Ethereum they could be created more easily. As a result, Ethereum has become practically synonymous with smart contracts, since most of them are developed there.

What are contracts?

Contracts are terms entered into between one or more parties. These terms set out the terms for financial transactions, monetary payments, and even marriages. A contract typically has the following parts (this applies to both physical and digital contracts):

• Signatories: are the parties who sign the contract. They can be two or more people and must be described throughout the instrument. Contract signatures can be made manually or digitally;
• Subject of the contract: is the type of contract being signed. For example, a real estate purchase and sale contract. In the case of a smart contract, it needs to have access to the content of the object;
• Terms of contract: These are the clauses that make up the contract. In the case of smart contracts, they need to be written clearly and in language appropriate to the type of written contract.

Advantages of Smart Contracts

Smart contracts have some advantages over their traditional counterparts. After all, we live in an increasingly connected and technology-dependent world. As a result, the use of paper contracts tends to become less and less efficient. The main advantages of smart contracts are:

• Language: Traditional contracts usually contain a series of clauses in complex legal language. Furthermore, this language can be quite interpretative, causing legal uncertainty. Smart contracts, on the other hand, value simplicity and their clauses cannot be changed, providing greater security for the parties;
• Costs: Conventional contracts are expensive. They involve spending on paperwork, notary offices, authentications and other bureaucracy that can make negotiations unfeasible. Smart contracts eliminate or reduce these intermediaries, generating much lower costs and greater efficiency;
• Agility in negotiations: Conventional contracts can be broken, generating a legal dispute that can take years to resolve. Smart contracts, on the other hand, have clauses that execute themselves, or are blocked in the event of a breach of contract. Again, this eliminates intermediaries and saves time in negotiations;
• Security: Smart contracts are nearly impossible to hack if implemented correctly. Furthermore, the blockchains that implement the contracts are usually quite secure and preserve both the documents and the security and privacy of the parties.

Risks of smart contracts

Smart contracts are a very promising technology. However, they are not risk-free. Despite their strong security, there are some factors that should be considered as risks when implementing these tools. The main ones are:

• Little history: Smart contracts have been around for just over 10 years. Therefore, they are still a tool under development. You need to be careful when choosing the best blockchain and other tools to create your contract;
• Code risk: A smart contract can be written with vulnerable code. If this happens, the outcome can be very serious. As happened with the DAO case in 2016, where a flaw in the code led a hacker to steal $150 million from this contract. Therefore, the code must not contain any trace of flaws or loopholes that can be exploited;
• Government action: Since smart contracts are a new technology, they are still viewed with suspicion. No government yet knows how to regulate these tools or how to tax the value of the contracts. Therefore, there is a risk that governments will severely limit or even ban them.

However, it is a fact that smart contracts are here to stay. Today, they are already used in many forms of business. Because of this, cryptocurrencies such as ETH have reached a very high market value in recent years. And as these contracts are used more, the more resilient and secure the technology tends to become.

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