What Is a Smart Contract?

The first definition of smart contracts was provided by Nick Szabo in 1997: “Smart contract is a computerized transaction protocol that executes the terms of a contract. The general objectives are to satisfy common contractual conditions (such as payment terms, liens, confidentiality, and even enforcement), minimize exceptions both malicious and accidental, and minimize the need for trusted intermediaries. Related economic goals include lowering fraud loss, arbitrations and enforcement costs, and other transaction costs”. In a nutshell, smart contracts are self-executing contracts with the terms of the agreement directly written into code, with the blockchain that serves as a repository for the contract’s code and agreements, allowing the contract to be automatically executed when specific requirements are satisfied.

Before the advent of the Internet, the parties who shared any contractual relationship needed to rely on third parties to establish, discipline, and extinguish the relationship, and to enforce the rules governing it. A first intermediation mechanism is the fact that all transactions necessarily involved the financial system, therefore the banks. Secondly, all the transactions, even if indirectly, implicated the involvement of all the powers of the state/government (or of private bodies linked to the state/government). All this is because we have to rely on some regulations that allow us to move within a defined framework of rules. Lastly, a further necessary intermediary was constituted by the monetary system, which is the legal means for the fulfillment of pecuniary obligations, constituted by a currency created by the state/government.

After the advent of the Internet, the area of commercial relationships expanded, as a series of “contractual relationships” took place through the Internet itself. The Internet allows the parties that share a contractual relationship to communicate information and data regarding business relationships. This ranges from the phase of the constitution of the contractual relationship, passing through the phase in which the parties can exchange the necessary consent, up to the executive phase, in which the parties can also execute some of their obligations through the internet.

With the advent of Bitcoin and blockchain technology, parties who share any contractual relationship finally have the ability to transfer digital value without having to rely on any intermediary. Therefore, the system takes on new features, becoming:

• Permissionless and open: Anyone can join the network, as well as check information about what is happening in the system.
• Borderless: There are no legal restrictions and/or government-imposed limits.
• Censorship resistant: It refers to the ability of the network to continue functioning even if a central authority tries to prevent it. The decentralized and transparent nature of blockchain technology makes it particularly resistant to censorship. Transactions are verified and recorded across a network of nodes, so they are irreversible and ‘finalized’.

Smart contracts allow you to program transactions so that they are executed when a specific term expires or when a certain condition is met. When designed correctly, they can solve many problems that still exist in the contracting arena today, such as corruption events by third parties or modification of contract terms by either party. The development of advanced smart contracts has led to the creation of the so-called ‘decentralized applications’ (dApps), which are applications that run on decentralized blockchain networks.Smart contracts provide dApps with a secure and transparent method for managing digital assets, executing transactions, and enforcing rules and regulations by incorporating the terms and conditions of the application directly into the code.

Decentralized Applications

Decentralized Applications (dApps) represent one of the first real use cases of the blockchain. By utilizing smart contracts, dApps eliminate the requirement for a centralized authority, offering increased transparency, security, and dependability when compared to traditional centralized applications. These features make dApps a suitable solution for a wide range of industries and use cases.

The advent of Ethereum has led to a significant increase in the creation of more sophisticated smart contracts. With the expansion of Ethereum and its ecosystem, individuals started exploring the possibilities of creating decentralized financial services platforms, also known as DeFi. By combining various smart contracts, operations that were once considered impossible, such as lending, liquidity management, and collateralization, have become possible. However, as dApps become increasingly complex, certain issues have arisen, such as bugs or malfunctions during transaction execution, which have resulted in instances of hacking or loss of funds in some early experimental applications. Following the example of Ethereum, its smart contracts are written in Solidity, which is a language called Turing Complete. This feature allows it to be programmed to perform almost any task, making it difficult to ensure its security and guarantee that the DApp is free of bugs or that its malicious use will not cause harm to users. Due to this, the emergence of code auditors took place over time. These auditors are responsible for examining the code and identifying any flaws. Generally, a dApp that was audited by these entities is considered reliable, but this does not guarantee that there is zero risk of malfunction. The security of a DApp depends on its history and longevity. If it has successfully managed substantial amounts of capital over a long period of time without being hacked, it is more likely to be secure. The same precaution always applies: it is always good to do your own research before delving into something that you still know little about, in order to avoid unpleasant surprises.

Examples of Use Cases:

As already mentioned, dApps can be an ideal solution for various industries and use cases. Below are some of these:

• Finance: Decentralized crypto exchanges (DEXs) and peer-to-peer lending & trading platforms are among the most popular financial dApps;
• Supply Chain Management: By tracking every transaction and movement of goods on a public blockchain, dApps can improve efficiency and transparency;
• Identity Management: Users may encrypt and manage their personal information using dApps, enabling safe and private online transactions;
• Payment Systems: dApps can allow for secure and fast transfers of funds without the need for intermediaries such as banks or payment processors. This can result in lower fees and faster transaction times;
• Gaming: Decentralized gaming platforms allow players to trade in-game items and currency without the need for a centralized authority;
• Healthcare: dApps can securely store and manage medical records and other sensitive health information.
• Cybersecurity: The use of blockchain technology can enhance cybersecurity in several ways. For instance, the decentralized and distributed nature of blockchain, together with the use of cryptographic algorithms, makes it difficult for hackers to attack and compromise the system.

These are just a few examples of the many potential use cases of dApps. The number of use cases will probably increase, as technology continues to develop and mature. Currently, the DeFi sector has seen the most widespread use of dApps, with hundreds of applications now managing billions of dollars. Applications such as Aave and Uniswap are excellent examples of protocols that work perfectly and meet user expectations. Both of them are part of the growing DeFi ecosystem and have gained significant traction in recent years, due to the increasing demand for decentralized financial services.

Highlights
Smart contracts are tools capable of improving common contractual conditions, minimizing the need for trusted intermediaries. They allow you to program transactions so that they are executed when a specific term expires or when a condition occurs.
Smart contracts have favored the creation of decentralized applications (dApps), which represent one of the first real use cases of the blockchain. The dApps considered safer are those that have been audited and boast greater longevity.
dApps represent one of the first real use cases of the blockchain. They are an ideal solution for various industries, such as finance, supply chain management, identity management, and payment systems.

Conclusion

This part of the course is intended to help you understand what smart contracts are and how they are able to improve contractual relationships between two or more entities. In addition, we have seen how these have fostered the creation of the first decentralized applications, which can be used in various industries. In the next module, we are going to cover the topic of supply chain and logistics, which is another use case of blockchain.