Smart contracts are simply programs with self-executing lines of code that perform a specific function under conditions that are agreed upon in advance by two or more participants involved in the transaction. They are used on private and public blockchains to manage transactions without the need for a third-party intermediary. Smart contracts are programmed with one of a number of languages that are designed for this purpose, with Solidity and Vyper being two of the most common options. Anyone can create and deploy smart contracts—like most things associated with blockchain technology, there are no gatekeepers or application procedures that could bar the participation of an aspiring developer. This technology has a longer lineage than you might think, in conceptual terms if not real-world implementation. Smart contracts were first proposed in the mid 1990s by computer scientist Nick Szabo, who went on to create the influential "Bit Gold" virtual currency—a predecessor of Bitcoin—in 1998. Today, they form an integral element of DeFi, enabling a wide variety of transactions to be carried out with unequaled speed and efficiency.  

How Smart Contracts Work

A smart contract is a type of program, written in a specific programming language, that exists on a blockchain. Its code takes the form of if-then statements, where the logic is executed once certain conditions are fulfilled. Typically, the code is extensively vetted before it is deployed on the blockchain to ensure that no bugs or errors are present. The smart contract receives updates from a data source, or oracle, to trigger certain events. For instance, if the contract is designed to be executed on the last day of the month, the oracle transmits the relevant information (the arrival of the date) at the predetermined time. The execution of the code results in the release of digital currency, transmission of sensitive data, or another action that has been determined in advance by agreement of the participants. Smart contracts execute automatically; they do not require human involvement in order to perform properly or to interpret the provisions in question. Their actions are generally immutable and irreversible, which helps foster trust among users. 

Uses of Smart Contracts

Smart contracts are already in use in a broad spectrum of industries to facilitate certain business functions. Current applications include:

NFT transactions - Smart contracts have found a vital role in the burgeoning field of non-fungible tokens, helping buyers and sellers trade these digital products with ease. 

Voting - Smart contracts are used by certain organizations to create a simple, easy-to-manage voting system that can aid in the election of board members or establishment by consensus of organizational rules and procedures.

Supply chain support - Smart contracts are currently used to track the delivery of products through the supply chain. Relevant applications include resolving disputes between vendors and tracking pharmaceutical products that must be stored within a specific temperature range.

Flight insurance - Smart contracts are also used to manage flight insurance payouts once certain predetermined conditions are met—e.g., a flight is delayed by at least three hours. 

Real estate transactions - Smart contracts have been used to manage title transfers and similar procedures.

Transfers of funds - Smart contracts enable funds to be transferred from one entity to another once a specific period of time has elapsed, or when another stipulation is fulfilled. Bond payments are just one type of transfer that can be aided with the use of smart contracts. 

Advantages of Smart Contracts

Smart contracts have become increasingly common in the DeFi field, and it’s no mystery why: they provide a variety of benefits that, like many aspects of the decentralized financial world, cannot be matched by traditional banking institutions. Benefits of smart contracts include:

Speed - Smart contracts are executed immediately, provided that the proper conditions have been met. There is no need for a third-party intermediary to verify the transaction, and the involved parties never have to wait until "banking hours" for fulfillment.

Cost-effectiveness - Smart contracts do not incur the various transaction fees associated with traditional banking. This is partly due to fewer intermediaries as well as the speed in which contracts are executed. Verifying one of these transactions is a relatively simple process, and one that has the potential to streamline certain business operations that have traditionally extended across multiple enterprises. (However, transactions may incur “gas” fees, which are paid in the blockchain network’s native currency. These fees, essentially maintenance charges necessary to sustain blockchain operations, are incurred by a wide variety of transactions.)

Elimination of human error - Autonomous execution of contracts takes away the possibility of error that may be introduced when verification or data entry is performed by human hands. This helps ensure transaction accuracy and reduce error-related costs. 

Privacy - With encryption, transactions on private blockchains can be effectively shielded from potential threat actors.

Security - Smart contracts benefit from the immutability offered by blockchain technology—transactions cannot be altered after the fact (although there are exceptions to this rule). Hacking of a block cannot be achieved without falsifying all previous blocks on the chain, which makes unauthorized tampering extraordinarily difficult. The many advantages of smart contracts over traditional transaction controls will undoubtedly aid in disseminating this technology across more industries and organizations in the coming years.

Limitations of Smart Contracts

It should be noted that smart contracts are not without their drawbacks, such as:

Legal ambiguity - Are smart contracts enforceable in the “real world”? That can be difficult to determine. Their legal status exists in a gray area, as they lack the generations of court precedents associated with old-fashioned contracts. 

Difficult to correct errors - A bug or error in programming can have cascading effects that are not easily rectified.

Lack of real-time HTTP access - Smart contracts cannot send API requests and are dependent on oracles to transmit “off-chain” data to execute logic that can trigger transactions. However, oracle nodes can be compromised by accidental failures or deliberate actions of hackers—this vulnerability is widely termed “the Oracle Problem.” These shortcomings may be eventually minimized or eliminated as programmers continue to devise ways to improve this technology.

Avalanche: Your State-of-the-Art Smart Contracts Platform

Measured by time-to-finality, Avalanche (AVAX) is the fastest smart contracts platform currently operating in the blockchain world. With Avalanche, you have the tools necessary to build Solidity-compatible dApps, launch custom blockchains, and quickly trade digital assets. To learn more about our smart contracts platform, explore the Avalanche website.