What is a Smart Contract?
A smart contract is a type of agreement that is executed as code running on a blockchain, such as Ethereum.
Unlike traditional contracts, smart contracts utilize the security, reliability, and accessibility of blockchain technology to enable sophisticated peer-to-peer functionality. With smart contracts, developers can create applications for various purposes, ranging from loans and insurance to logistics and gaming.
A Closer Look
Just like a conventional contract, smart contracts establish the terms of an agreement. However, what sets them apart is that these terms are written and executed as code on a blockchain rather than on paper.
By building upon the principles of cryptocurrencies like Ethereum, smart contracts provide the ability to automate and decentralize complex deals or transactions securely.
The Importance of Smart Contracts
Smart contracts empower developers to build decentralized applications (dapps) and tokens for a wide range of use cases, including finance, logistics, and gaming. These contracts are stored on blockchains alongside other crypto transactions. Once added to the blockchain, a smart-contract-powered app typically becomes irreversible or unchangeable (with some exceptions).
Decentralized applications or "dapps" leverage smart contracts, and they play a significant role in transforming industries like banking through the emergence of decentralized finance (DeFi) technology.
DeFi apps enable cryptocurrency holders to engage in various financial transactions, such as exchanging currencies, saving with interest, loans, and insurance, without intermediaries like banks taking a share. Some popular examples of smart-contract-powered applications include Uniswap, AAVE, and USDC.
Using Smart Contracts
To illustrate how smart-contract-powered tools can be utilized, let's say you want to trade your Ethereum for USDC. By leveraging Uniswap, you can input your Ethereum, and through the power of smart contracts, the platform will automatically find the best exchange rate, execute the trade, and deliver your USDC.
Furthermore, you can lend some of your USDC through AAVE without involving banks or financial institutions, earning interest determined algorithmically. Smart contracts make these previously challenging and insecure scenarios possible.
Understanding How Smart Contracts Work
The concept of smart contracts was initially conceived by computer scientist and lawyer Nick Szabo in the 1990s. Szabo famously compared a smart contract to a vending machine—automating exchanges without human intermediaries. This analogy helps understand how smart contracts can automate various types of transactions.
While Ethereum remains the most popular platform for smart contracts, other cryptocurrency blockchains like EOS, Neo, Tezos, Tron, Polkadot, and Algorand can also support them. Any individual can create and deploy a smart contract on a blockchain. The code of these contracts is transparent, publicly verifiable, and accessible to interested parties, allowing them to understand the logic and functionality behind each contract. Popular tools for this are block explorers like Etherscan.
Executing Transactions Securely
Every computer node in the network maintains a copy of all existing smart contracts, along with the blockchain and transaction data. When a user sends funds to a smart contract, all nodes execute its code to reach a consensus on the outcome and value flow.
Executing a smart contract on the Ethereum network typically incurs a fee known as "gas," which incentivizes the computer nodes in the network to operate and verify the interactions in the network.
Once deployed on a blockchain, smart contracts are generally immutable, meaning they cannot be altered. Some creators choose to use proxies, although upgrades are transparent, and old contracts will always still be available to read. This immutability ensures that smart contracts cannot be easily censored or shut down, contributing to their trustworthiness.
Indexing and Querying Smart Contract Interactions
Building on a smart contract can be challenging. Data is submitted through an encoded set of data corresponding with the code in a smart contract. Developers usually rely on indexers such as Basement or The Graph to show interactions in their app or analyze usage.
For Ethereum, smart contract developers emit events when noteworthy events happen. In the example of a token like USDC there is a Transfer event. For NFT contracts, a common event is the Approval, used for allowing exchanges to trade tokens on your behalf