Smart Contracts: How Self-Executing Code is Automating Agreements and Disrupting Industries

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7 Sept 2023

A smart contract is a self-executing agreement written in computer code that is stored and executed on a blockchain. Smart contracts allow for automated, decentralized execution of agreements between parties, removing the need for intermediaries.

The code contains the logic and rules that mimic legal contract clauses. When certain conditions are met, the smart contract auto-executes the corresponding contractual clauses. This eliminates the need for manual oversight and intervention by any third party.

The key benefit of smart contracts is the removal of counterparty risk. Once deployed on the blockchain, the smart contract code cannot be changed, and will execute automatically when the predefined conditions are triggered. This provides security and predictability in commercial transactions.

Some key features of smart contracts:

Self-executing - Smart contracts auto-execute once conditions are met, without the need for human intervention. This removes reliance on intermediaries.
Immutable - The code cannot be changed once deployed on the blockchain. This guarantees predictable execution.
Transparent - Smart contracts and their execution/outcomes are visible to all participants on the blockchain network. This promotes trust.
Reduction in transaction costs - Removing intermediaries can significantly reduce costs associated with legal agreements and transactions.
Accuracy - Smart contracts execute automatically when conditions are met, reducing the likelihood of errors and disputes.
Trust - cryptographic security and immutability of blockchain fosters trust between unfamiliar parties.
Efficiency - automation and removal of intermediaries significantly improves speed and efficiency.

Some common examples of how smart contracts are being used:

Financial derivatives - Smart contracts can execute trades, payments, and cash flows for financial instruments. This eliminates middlemen and manual oversight.
Insurance - Smart contracts can automate insurance claims processing and payments based on event outcomes such as flight delays, crop damage etc.
Supply chain - Smart contracts can track inventory, orders, delivery status, and trigger payments automatically through a supply chain.
Real estate - Smart contracts can execute property sales, transfers, and rentals based on predefined conditions.
Identity management - Smart contracts can store and manage digital identity credentials and restrict access to resources.
Voting - Smart contracts can automate and enforce voting rules, and transparently tally results.
Governance - Decentralized Autonomous Organizations (DAOs) use smart contracts to codify governance rules on blockchain.
Royalties distribution - Smart contracts can automatically distribute royalties to appropriate parties when digital content is used.
Fraud prevention - Smart contracts can verify credentials, proofs of origin, ownership etc. to minimize fraud.
Legal records - Key legal documents like contracts, transfers of title can be stored securely on blockchain via smart contracts.
Wallets - Cryptocurrency wallets use smart contracts to allow users to easily transfer funds and interact with dApps.

How Smart Contracts Work

Smart contracts contain executable code that is run deterministically by the blockchain network when specified conditions are met. Here is a typical workflow:

The smart contract code is written in a language like Solidity, compiled into bytecode, and deployed to the blockchain by making a transaction.
User applications can then interact with the deployed smart contract by submitting blockchain transactions that call the contract's functions.
The nodes on the blockchain network will run the smart contract code as part of confirming the user's transaction.
If certain conditions defined in the contract are met, the corresponding code statements will execute to completion. This can involve computing new values, storing data, calling other contracts, and disbursing cryptocurrency.
Execution will finish, and the changes made by the smart contract will be updated and recorded on the blockchain along with the original transaction.
All participants on the blockchain can see the transaction, smart contract execution, and resulting state updates.
The immutable nature of the blockchain means that the smart contract will always produce the same output for a given input, and no party can interfere with execution.
This allows the blockchain network to automatically enforce contractual agreements and business logic as coded in the smart contract.

Key Elements of a Smart Contract

Here are some of the key elements generally contained in a smart contract:

Contract parties - The counterparties to the agreement are identified by their blockchain addresses.
Contract terms - The obligations, rights, covenants, representations, and other terms that govern the agreement.
Inputs - The data that needs to be supplied to the smart contract by the counterparties or from outside sources like data feeds.
Conditions precedent - The pre-conditions that must be satisfied before the agreement goes into effect.
Logic - The executable functions that mimic legal clauses and implement business logic using conditional statements like "if/then", while loops, Boolean logic etc.
Variables - Storage areas to maintain state information like account balances, ownership records etc.
Events - Notifications that are triggered when certain conditions are met. DApps can listen for these event notifications.
Interactions - Functions that allow the counterparties and applications to read from and write data to the contract.
Execution - How contract logic will be processed based on supplied inputs and stored state variables.
Immutability - Once deployed, the contract code cannot be modified by any party.

Advantages of Smart Contracts

Here are some of the key advantages that smart contracts on blockchain networks provide:

Autonomy - Smart contracts operate autonomously without human intervention once deployed. This removes reliance on availability of intermediaries.
Trust - Users can trust that the smart contract will execute reliably and impartially based on the coded agreements.
Accuracy - Automated execution avoids manual errors and provides accurate fulfilment of agreement conditions.
Transparency - Contract terms, execution, and outcomes are visible to all network participants through the transparent blockchain ledger.
Savings - Smart contracts remove overhead costs of middlemen which reduces transaction fees.
Backup - The blockchain maintains a decentralized backup of the smart contract code and data. Loss of data is near impossible.
Safety - Data encryption, digital signatures, and immutability makes smart contracts secure against fraud and tampering.
Speed - Automated execution allows for faster fulfilment of contractual obligations and transactions.
Stability - Smart contracts are unaffected by external economic, political or personal conditions once deployed.
Precision - Smart contracts can handle complex agreements and execute intricate business logic with precision.
Scalability - Smart contracts can coordinate and execute distributed transactions at scale.

Limitations and Challenges

While smart contracts provide many benefits, there are also some limitations and challenges to consider:

Coding complexity - Writing smart contract code that handles all edge cases and functions reliably can be challenging. Bugs can cause losses.
Gas costs - Running smart contract code on blockchains like Ethereum requires payment of gas fees which can make certain use cases prohibitively expensive.
Contract inflexibility - Smart contracts are immutable once deployed, making bug fixes and upgrades difficult.
Oracles - Smart contracts need external data feeds to execute certain logic which requires trust in oracle providers.
Privacy - Transparency of the blockchain means private data should not be stored in smart contracts. Solutions like zero-knowledge proofs are being developed to overcome this.
Legal standing - The legal framework around smart contracts is still evolving and remains unclear in most jurisdictions.
Developer education - Many developers are still learning best practices around secure smart contract programming which can lead to faulty code and vulnerabilities.
User experience - Interacting with smart contracts directly requires technical know-how, so UX remains a challenge.
Scale - While blockchains are scalable, high volumes can impact performance and cost.
Governance - Upgrading smart contract code to patch bugs and add features requires coordinated governance and consensus processes.

Real World Smart Contract Examples

Here are some real world examples of live smart contracts across different industries and use cases:

Decentralized Finance (DeFi) - Smart contracts power decentralized trading, lending and borrowing platforms like Uniswap, Aave and Compound by codifying interest rates, collateral terms etc.
Supply chain - Walmart uses smart contracts on Hyperledger Fabric blockchain to track and trace food products from farm to shelf, improving safety.
Insurance - Arbol offers parametric weather insurance that pays out automatically based on weather data feeds. The entire policy and claims process is handled by smart contracts.
Real estate - Propy allows buyers and sellers to execute real estate transactions over Ethereum blockchain through smart contracts. Deed and keys are exchanged automatically upon payment.
Gaming - Games like Ethereum-based Cryptokitties allow users to breed, trade, and sell virtual cats in a decentralized manner using smart contracts to confer digital ownership rights.
Identity - uPort uses smart contracts on the Ethereum blockchain to provide users with sovereign digital identities that can securely store claims like credentials and vote in applications.
Payments - OmiseGO enables real-time, low-cost payments in fiat and cryptocurrencies using the OMG network and Ethereum smart contracts that connect users and merchants.
Digital media - Ujo Music enables musicians to sell and get paid for songs and albums with full transparency by writing the licensing terms into smart contracts on the Ethereum blockchain.
Governance - MakerDAO uses smart contracts to codify governance rules and bylaws for its stablecoin and decentralized lending platform in a transparent and equitable way.

These examples demonstrate the broad applicability of smart contracts across many different domains and use cases. As adoption increases, smart contracts hold the potential to automate and revolutionize wide-ranging business and legal processes.

Popular Smart Contract Platforms

Several blockchain platforms have emerged that allow developers to write, deploy and execute smart contracts:

Ethereum - The first blockchain with built-in Turing-complete scripting language that allows developers to write smart contracts. It remains the most popular platform.
Solana - Fast, scalable blockchain with growing adoption built to host decentralized applications and smart contracts.
Polkadot - Enables cross-chain smart contracts and interconnects public and private blockchains.
Cardano - Developing extended smart contract capabilities aimed at enabling legal contracts and regulators.
Algorand - Proof-of-stake blockchain that supports smart contracts and offers speed/scalability improvements over older platforms.
Hyperledger - Allows creating private blockchains optimized for running smart contracts, used primarily by enterprises.
Tezos - Self-governing blockchain with formal smart contract verification system and ability to upgrade itself via proposals and votes.
Cosmos - Scalable ecosystem of interoperable blockchains, each of which can run smart contracts.
Near Protocol - High-performance blockchain purpose built for smart contracts and dApps with ease of use emphasis.

Each platform has its own advantages and tradeoffs around transaction fees, speed, scalability, versatility, governance, and levels of decentralization.

Smart Contract Languages

Smart contracts are written in specialized programming languages tailored to interact with blockchain networks:

Solidity - An object-oriented, high-level language for writing smart contracts on Ethereum and other EVM-compatible blockchains.
Vyper - Pythonic smart contract language also for EVM blockchains focused on security and simplicity. Avoid overflow bugs.
Bamboo - A new smart contract language by Algorand that offers both Python and Go flavours to cater to different developers.
Clarity - Optimized for predictability and security, Clarity is used for smart contracts on the Stacks blockchain.
Michelson - Strongly typed, low level language used to write smart contracts on the Tezos blockchain.
Rust - Fast, memory-safe language being explored by Solana, Polkadot for writing secure smart contracts.
Simplicity - Haskell-based typed, functional language designed for Cardano blockchain smart contracts.
Scilla - Ocaml-based language built by Zilliqa specifically for writing secure smart contracts.
DAML - Originally created by Digital Asset for private blockchains, now being compiled to run on public ledgers.
Ink! - Ethereum-based smart contract language built using the Rust programming language syntax and tooling.

Each language offers different advantages around security, safety, simplicity and functionality depending on the target blockchain and applications.

Smart Contract Security Considerations

Since smart contract code is immutable once deployed and cannot be easily updated, writing secure code is crucial. Some security best practices include:

Rigorous testing - Thoroughly test smart contract functionality under different conditions to find flaws and weaknesses.
Formal verification - Use mathematical proofs to verify logical correctness of smart contract code and identify bugs.
Audit code - Conduct professional smart contract audits to identify vulnerabilities before mainnet release.
Use established tools - Use well-tested frameworks, libraries and static analysis tools to minimize custom code.
Keep contracts simple - Modularize contracts into smaller functions to minimize complexity and attack surfaces.
Limit authorization - Be selective in setting permission controls for critical operations.
Add overflow checks - Avoid integer overflows which can manipulated to modify state in unexpected ways.
Monitor events - Watch event logs to identify abnormal behavior.
Freeze critical functions - Make business-critical functionality upgradable in case bugs arise later.
Incentivize hacking - Offer bug bounties to encourage ethical hackers to find flaws.
Use multiple languages - Write contracts in different languages and compare results to expose inconsistencies.

Smart contract security is an active area of research as billions of dollars are now locked in DeFi and other dApps. Ongoing language research aims to remove entire classes of bugs at the compiler level.

Oracles

Smart contracts require access to external data and events to execute certain logic. Oracles are services that provide this connectivity to off-chain data for consumption by smart contracts.

Examples of data supplied by oracles:

Weather data for crop insurance payouts
Flight status for travel insurance claims
Sports scores for prediction market resolutions
Real-world prices for DeFi price feeds
Random numbers for lottery/gambling applications
Identity verifications for KYC compliance

Oracles introduce trusted third parties and points of failure. Decentralizing and securing oracles remains an active area of research. Strategies include:

Using multiple redundant oracles for the same data to minimize trust
Allowing users to challenge/verify oracle outputs for a reward
Appointing expert oracles restricted to certain data domains like weather
Checking real world state regularly to identify faulty or manipulated oracles
Requiring oracles to stake tokens as collateral which can be slashed for misbehavior

As smart contracts adoption increases, oracles will become a critical component of blockchain infrastructure.

Decentralized Apps (dApps)

Decentralized apps (dApps) are applications built on top of public blockchains like Ethereum that use smart contracts on the backend.

Key properties of dApps:

Open source code that runs on a blockchain
Application logic and data stored on-chain via smart contracts
Cryptographic tokens used for ownership, transactions, governance
Protocol and governance rules enforced on-chain via consensus
No central point of control - records are maintained by a distributed cluster of nodes
User interactions happen through a client or browser-based front end

Examples of popular Ethereum dApps:

Crypto wallets like MetaMask, Coinbase Wallet that allow interacting with dApps
Decentralized exchanges like Uniswap, Sushiswap
Lending/Borrowing platforms like Aave, Compound
Prediction markets like Augur for betting on events
Collectible games like Axie Infinity
Tokenized content platforms like Audius for music
Virtual worlds like The Sandbox, Decentraland
Lotteries like PoolTogether

Emerging Use Cases

Here are some emerging use cases and applications of smart contract technology:

NFT platforms - For minting, trading, and tracking ownership and usage rights of non-fungible tokens.
Tokenized securities - Smart contracts can automate cap table management and dividend payments for tokenized traditional assets.
Royalties distribution - Musicians/content creators can distribute royalties automatically to all contributors when works are used.
Electric vehicle charging - Smart contracts can automatically authenticate vehicles, unlock charging stations, and process payments.
Smart grid - Autonomously manage demand response based on energy supply and usage patterns.
Autonomous vehicles - Self-executing smart contracts between vehicles, roads, usage pools etc. can enable next-gen transportation.
Decentralized social networks - Build censorship-resistant social networks where users control their own identities, data, and online relationships.
Sharing economy - Create decentralized Uber/AirBnb alternatives where smart contracts govern peer-to-peer transactions.
Indie games - Smart contracts can represent game assets and rules to support user-generated mini games as NFTs.
Anti-spoofing - Smart contracts can prevent ticket scalping, counterfeit goods etc. by managing certified digital assets
Secure voting - Create transparent, fraud-resistant digital voting mechanisms through smart contract automation.

Smart contracts are poised for continued rapid growth as they find new applications across all industries. But like any transformative technology, smart contracts need further refinement and research to fully deliver on their potential while managing risks and limitations.
Overall smart contracts represent an important milestone in humanity's quest to replace top-down human institutions with open, transparent, equitable systems governed by impartial code. With ever-improving languages, tools, and best practices, smart contracts may fulfill that lofty vision.