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A smart contract, like every other contract, lays down the terms of an arrangement. However, unlike a standard contract, the terms of a smart contract are implemented as code running on a blockchain such as Ethereum. Smart contracts allow developers to create applications that leverage blockchain stability, reliability, and usability while providing sophisticated peer-to-peer features ranging from loans and insurance to logistics and gaming.
Smart contracts, like every other arrangement, spell down the terms of an arrangement or transaction. Smart contracts, on the other hand, are distinguished by the fact that the terms are defined and implemented as code running on a blockchain, rather than on paper sitting on a lawyer’s desk. Smart contracts build on the fundamental concept of Bitcoin — sending and receiving money without a “trusted intermediary” like a bank in the middle — to allow the safe automation and decentralisation of nearly any kind of deal or exchange, no matter how complex. And, since they are based on a blockchain, such as Ethereum, they have anonymity, dependability, and borderless accessibility.
Why are smart contracts important?
Developers will use smart contracts to create a wide range of decentralised applications and tokens. They’re used in everything from new finance technologies to infrastructure and gaming experiences, and they’re kept on a database much like every other cryptocurrency purchase. If a smart-contract app is applied to the blockchain, it cannot be altered or reversed (although there are some exceptions).
Smart-contract-powered software are also known as “decentralised applications” or “dapps,” and they include decentralised finance (or DeFi) technology, which seeks to change the banking industry. DeFi apps allow cryptocurrency investors to conduct complicated financial transactions — investing, loans, and insurance — without the involvement of a bank or other financial entity, and from anywhere in the world. Among the more common existing smart-contract-powered applications are:
Uniswap: A decentralized exchange that allows users, via smart contract, to trade certain kinds of crypto without any central authority setting the exchange rates.
Compound: A platform that uses smart contracts to let investors earn interest and borrowers to instantly get a loan without the need for a bank in the middle.
USDC: A cryptocurrency that is pegged via smart contract to the US dollar, making one USDC worth one U.S. dollar. UDDC is part of a newer category of digital money known as stablecoins.
So, how can you put these smart contract-enabled tools to use? Assume you have some Ethereum that you want to sell for USDC. You could bring any Ethereum into Uniswap, which will automatically find the best exchange rate, make the deal, and give you your USDC via smart contract. You will then invest any of the USDC in Compound to lend to others and earn an algorithmically calculated interest rate — all without using a bank or other financial institution.
Swapping currencies is a costly and time-consuming process in conventional finance. It is therefore difficult and risky for people to lend their liquid assets to strangers on the other side of the planet. Smart contracts, on the other hand, allow all of these situations, as well as a plethora of others.
How do smart contracts work?
Currently, Ethereum is the most common smart contract network, but they can be run on a variety of cryptocurrency blockchains, like EOS, Neo, Tezos, Tron, Polkadot, and Algorand. Anyone can build and deploy a smart contract to a blockchain. Since their code is open and easily verifiable, any involved person will see precisely what rationale a smart contract applies as it receives digital properties.
Smart contracts are written in a variety of programming languages (including Solidity, Web Assembly, and Michelson). On the Ethereum network, each smart contract’s code is stored on the blockchain, allowing any interested party to inspect the contract’s code and current state to verify its functionality.
Each computer on the network (or “node”) stores a copy of all existing smart contracts and their current state alongside the blockchain and transaction data.
When a smart contract receives funds from a user, its code is executed by all nodes in the network in order to reach a consensus about the outcome and resulting flow of value. This is what allows smart contracts to securely run without any central authority, even when users are making complex financial transactions with unknown entities.
To execute a smart contract on the Ethereum network, you will generally have to pay a fee called “gas” (so named because these fees keep the blockchain running).
Once deployed onto a blockchain, smart contracts generally can’t be altered, even by their creator. (There are exceptions to this rule.) This helps ensure that they can’t be censored or shut down.