What Is Smart Contract?

Smart contracts were first described by Nick Szabo in the 1990s. At the time, he defined smart contracts as a tool that formalizes and secures computer networks by combining protocols with user interfaces. In addition, Szabo discusses the potential use of smart contracts in various areas involving contractual protocols, such as credit systems, payment processing, and content rights management.

In the case of cryptocurrencies, smart contracts refer to a set of digital protocols that run on the blockchain and are enforced by a set of specific rules. These rules are predefined by computer code, copied and executed by all network nodes. In real life, a contract is a set of conditions and cations. For instance, if I pay the landlord $1500 on the first of the month, then I can use the apartment. Simultaneously, smart contract developers write the conditions for their program, and then the network executes them if certain conditions are met. The use of a smart contract enables both parties to a transaction can make promises through the blockchain without having to know or trust each other. They can be confident that if the conditions are not met, the contract will not be executed. As a result, the use of smart contracts can eliminate the need for intermediaries and significantly reduce operating costs.

Smart Contract Features

• Distributed — Smart contracts are replicated and distributed in all nodes of the network, which is one of the major differences from centralized servers.

• Deterministic — When the conditions are met, the smart contract only executes its designed operation and obtains the same result.

• Autonomous — Smart contracts can automate all sorts of tasks, working like a self-executing program.

• Immutable — Smart contracts cannot be changed after deployment. They can only be deleted if a particular function was previously implemented.

• Customizable — Before deployment, smart contracts can be coded in many different ways. Thus, they can be used to create many types of programs and applications.

• Trustless — Two or more parties can interact via smart contracts without knowing or trusting each other, while blockchain technology ensuring that the data is accurate.

• Transparency— Since smart contracts are based on an open-source blockchain, their source code is not only immutable but also visible to anyone.

Advantages

• As programmable code, smart contracts are highly customizable and can be designed in many different ways, offering many kinds of services and solutions. For instance, the creation of tokenized assets, voting systems, crypto wallets, decentralized exchanges, games, and mobile applications.

• As decentralized and self-executing programs, smart contracts may provide increased transparency and reduced operational costs. Depending on the implementation, they can also increase efficiency and reduce bureaucratic expenses.

Limitations

Smart contracts are made of computer code written by humans, which brings numerous risks as the code is subject to vulnerabilities and bugs. Ideally, they should be written and deployed by experienced programmers especially when involving sensitive information or a large amount of funds. In addition, smart contracts are not legal contracts, nor smart. They are just a piece of code running on a distributed system. Thus, smart contracts are actually uncompromisingly lettered strict and cannot take any secondary considerations or the spirit of the law into account. Once a smart contract is deployed on the Ethereum network, it cannot be edited or corrected, even by its original author. Being immutable can be great in some situations, but very bad in others. For example, when a Decentralized Autonomous Organization (DAO) called "The DAO" got hacked in 2016, millions of ether (ETH) were stolen due to flaws in their smart contract code. Since their smart contract was immutable, developers were unable to fix the code. This eventually led to a hard fork, giving birth to a second Ethereum chain.