Smart Contracts: Basic Concepts and 8 popular Use Cases

Smart Contracts: A Must-Know Term for Cryptocurrency Investors. If you're a cryptocurrency investor, you've undoubtedly heard the term "smart contract." Like many blockchain-related terms, the meaning of smart contracts might not be immediately clear when you first come across it. So, what exactly is a smart contract in the context of blockchain? When and how is it used? Let's delve into the details and explore what it really means.

TL;DR;

What is a Smart Contract?

The Dictionary Meanings of "Smart" and "Contract"

"Smart" is commonly used to mean "intelligent" or "clever." This word saw a significant increase in usage with the advent of the information age in the late 20th century. It began to be used to describe individuals equipped with skills suited to the digital era. In the field of information technology, "smart" encompasses meanings such as "mechanized," "computerized," "intelligent," and "information processing."Essentially, a "smart" person is someone who can efficiently utilize information and technology.

Today, the term "smart" is widely used in various IT-related fields, including smartphones, smart technology, and smart TVs. This widespread use reflects the integration of advanced technology into our daily lives.

The dictionary definition of "contract" is as follows:

"A formal agreement between two different people or groups, or a legal document that explains and specifies such an agreement."

By combining these two words, we can define a smart contract as a "formal agreement between two different parties (or groups) based on information processing."

The Birth of Smart Contracts

When do we usually make contracts? In everyday life, contracts are often made when sending money to family (remittances), trading stocks of a company we're interested in (stock trading), or buying and selling a house (real estate transactions). Essentially, any significant transaction involving money usually requires a contract.

The more important the transaction, the more critical it is for both parties to honor their commitments. To ensure legal enforceability in case of future disputes, a formal contract is created.

Let's visualize the process of a "remittance" transaction:

In this process, a third-party intermediary, the bank, is involved.

This involvement of a third party introduces transaction fees that individuals must bear and requires unquestionable trust in the intermediary's integrity to safeguard personal assets.

Efforts to address these issues in the digital realm began in the 1980s. In 1994, Nick Szabo introduced the term "smart contract" and outlined the concept. Finally, in 2015, with the advent of blockchain technology, the concept of "smart contracts" became a reality.

Tasks previously handled by third-party intermediaries in traditional transactions were transformed into deterministic pieces of code on the blockchain. Using an "If-Then" semantic, a smart contract executes the agreement when specific conditions are met.

Based on the decentralization, security, transparency, and anonymity characteristics of blockchain, smart contracts were implemented. The smart contract code is stored on the blockchain and executes exactly as written, ensuring reliability and security.

Ethereum and Smart Contracts

The first network capable of implementing smart contract code is Ethereum. Ethereum is the pioneering platform that combines blockchain with smart contracts. As mentioned earlier, smart contracts follow the "If-Then" semantic, making them relatively easy to program. Ethereum provides a platform where developers can create their own smart contracts using a programming language called Solidity.

Ethereum has created an environment where transactions can occur without third-party intermediaries and provided a system for developing applications that run on the network. This has paved the way for services such as tokens, NFTs, and decentralized exchanges (DEXs). In particular, decentralized finance (DeFi) is an industry heavily reliant on smart contracts.

 
Advantages and Disadvantages of Smart Contracts

Advantages

Smart contracts are programs registered on the blockchain, making them immutable and guaranteeing that they execute exactly as written. Here are some of their key advantages:

• 1. Elimination of Intermediaries and Cost Reduction
  There is no need for third-party intermediaries, which reduces costs.
• 2. Real-Time Execution and Simplified Transaction Procedures
  Smart contracts automatically execute once specific conditions are met, without the need for human intervention. There's no need to wait for manual interpretation or negotiation.
• 3. Transparency and Personal Information Security
  Ethereum connects to unique encrypted addresses rather than personal identities, protecting individual information.

Disadvantages

While smart contracts may seem complex, they are essentially computer programs with functions and variables that can be vulnerable to hacking and misuse. Attackers can potentially insert malicious features into the public code, gaining unauthorized access and stealing funds.

• 1. Vulnerable Security and Bugs
  One significant risk associated with smart contracts is the presence of bugs, which can be anticipated in any software. Since smart contracts serve as the contract itself, it's common to deploy and verify them by making the entire code public. However, this public exposure allows attackers to identify vulnerabilities and exploit them. A notable example is the DAO hack, which resulted in the loss of millions of dollars worth of Ether as attackers successfully drained funds from the smart contract. This incident led to a hard fork of Ethereum. (Related content: The History of Ethereum: From Inception to Major Events)
• 2. Contract Immutability
  

  Once a smart contract is deployed, it cannot be altered due to its immutability. While this feature can be advantageous, it can also be a drawback if changes or updates are needed.

• 3. Unclear Regulations and Tax Issues
  Although these issues might be resolved in the future, current regulations and tax implications for smart contracts remain unclear.

Real-World Examples of Smart Contract Applications

Token Issuance

Token issuance is one of the most prominent applications of smart contracts in blockchain technology. This process involves creating and distributing new cryptocurrencies or digital assets. Smart contracts automate the management of token supply, issuance schedules, and distribution methods. For instance, during an Initial Coin Offering (ICO), tokens can be automatically allocated to investors or gradually released over time according to complex logic programmed into the smart contract. Additionally, smart contracts can define the rights and responsibilities of token holders, ensuring transparency. Token issuance smart contracts follow standards such as ERC-20 (Ethereum) and BEP-20 (Binance Smart Chain), ensuring compatibility with various wallets and exchanges.

💡 Ethereum: Many ICO projects issue tokens on the Ethereum platform. For instance, projects like EOS and Tezos used Ethereum’s ERC-20 token standard for their initial fundraising.

Crowdfunding

Crowdfunding smart contracts provide a transparent and efficient way to raise funds, overcoming the limitations of traditional centralized platforms. The process typically involves: 1) Setting up the project's funding goals, duration, and minimum investment amounts; 2) Receiving and securely holding funds from investors; 3) Automatically transferring funds to project developers if the funding goal is met; 4) Issuing refunds to investors if the goal is not achieved. By eliminating intermediaries, crowdfunding smart contracts reduce fees and ensure transparency, as all transaction records are stored on the blockchain. They also facilitate milestone-based fund releases or investor voting systems to monitor project progress and encourage responsible fund usage. This model offers a new funding mechanism for startups, nonprofits, and creators, and enables global investor participation.

💡 Golem: a decentralized computing power sharing platform, raised funds through an ICO.

Decentralized Exchanges (DEX)

Decentralized exchanges (DEXs) use smart contracts to address the issues faced by centralized exchanges. These systems allow users to trade peer-to-peer while maintaining control over their own assets. DEX smart contracts implement complex logic for order book management, automated market maker (AMM) algorithms, and liquidity pool management. For example, AMM-based DEXs like Uniswap allow liquidity providers to deposit token pairs, which traders can use to exchange tokens. Smart contracts handle price determination, slippage calculations, and fee distribution automatically. DEXs operate 24/7 without relying on central servers, reducing the risk of hacking or service interruptions. Moreover, all transactions occur on-chain, enhancing transparency and auditability. DEXs offer advantages such as rapid listing of new tokens, privacy, and borderless trading, making them a key infrastructure in the DeFi (decentralized finance) ecosystem.

💡 Uniswap: An Ethereum-based decentralized exchange that allows users to exchange tokens through smart contracts.
💡 SushiSwap: Provides similar functionality to Uniswap, supporting trades through various liquidity pools.

Digital Identity Verification

Digital identity verification smart contracts offer an innovative solution for privacy protection and efficient identity management. In this system, users' personal information is not directly stored on the blockchain but is instead stored as hashed or encrypted values. Smart contracts allow users to have complete control over their identity information and disclose it selectively only when necessary. For example, in services requiring age verification, users can prove they are of legal age without revealing their exact date of birth. This is implemented using cryptographic techniques like Zero-Knowledge Proofs. Additionally, smart contracts can integrate and manage certifications from various identity verification authorities, allowing users to maintain a consistent identity across multiple platforms. This system minimizes the risk of personal data breaches, streamlines KYC (Know Your Customer) processes, and enhances the convenience of using digital services.

💡 Civic: A blockchain-based identity verification system that securely manages and verifies users' identity information.
💡 SelfKey: A platform for individuals and businesses to manage and verify digital identities.

Supply Chain Management

Smart contracts for supply chain management enable transparent and efficient tracking of products from production to final consumption. In this system, each participant (manufacturers, distributors, retailers, etc.) records information about the product's movement, quality checks, and storage conditions on the blockchain. Smart contracts automatically verify and update this data, approving the movement to the next stage when specific conditions are met. For example, in the food industry, smart contracts integrated with temperature sensors can automatically issue warnings and initiate insurance claims if proper temperature conditions are not maintained during transportation. Additionally, consumers can check the complete history of products via QR codes or RFID tags, enhancing trust and brand value. These systems are also effective in preventing counterfeiting, improving recall processes, and proving regulatory compliance, making them valuable across various industries.

💡 VeChain: A blockchain-based supply chain management solution that tracks the entire process from production to delivery.
💡 IBM Food Trust: A platform using blockchain technology to enhance transparency in the food supply chain.

Voting Systems

Blockchain-based voting systems using smart contracts overcome the limitations of traditional voting methods by implementing a more secure and transparent electoral process. In this system, each voter receives a unique digital ID and can vote only once, with voting records encrypted and recorded on the blockchain. Smart contracts automatically execute rules for voting periods, eligibility verification, and vote tallying. For instance, at the end of the voting period, the smart contract automatically closes the voting and aggregates the results. All participants can verify the results without the need for a central authority, ensuring transparency. Additionally, technologies like Zero-Knowledge Proofs can ensure voter anonymity while allowing voters to confirm their votes have been accurately counted. This system has the potential to be applied to corporate shareholder votes, community decision-making, and even national elections, enhancing the trustworthiness and efficiency of democratic processes.

💡 Horizon State: A blockchain-based voting platform that guarantees transparency and security in the voting process.
💡 Follow My Vote: An online voting system utilizing blockchain technology.

Insurance Contracts

Smart contracts for insurance automate and streamline the insurance claims and payment processes. In this system, the conditions of the insurance policy are encoded, and insurance payouts are triggered automatically when specific events occur. For instance, in weather insurance, a smart contract can integrate with reliable weather data sources (oracles) to automatically disburse compensation when certain criteria (e.g., rainfall, temperature) are met. This enables swift and fair payouts without the need for complex claim procedures or reviews. Additionally, smart contracts can automate processes such as premium payments, policy renewals, and installment payouts. This system can reduce operational costs for insurance companies and enhance customer satisfaction, especially in micro-insurance or peer-to-peer insurance models. It can also simplify complex settlement processes in reinsurance contracts involving multiple insurers.

💡 Etherisc: A blockchain-based decentralized insurance platform that automates insurance contracts through smart contracts.
💡 Lemonade: An insurance service that uses artificial intelligence and blockchain to simplify the insurance application and claims process.

In-Game Asset Management

In the gaming industry, smart contracts can revolutionize the management of digital assets, including in-game items, characters, and land. By representing these assets as non-fungible tokens (NFTs) and recording them on the blockchain, the uniqueness and scarcity of each asset are guaranteed. Smart contracts manage the creation, trading, and usage rules of these NFTs. For example, a smart contract can automatically issue special items upon completing a certain quest or level, or automatically distribute royalties to the original creator when an item is traded. Additionally, interoperability between games can allow assets acquired in one game to be used or traded in another. This enhances the transparency of the game economy, grants players tangible digital asset ownership, and enables new game business models such as Play-to-Earn. Such systems increase player engagement and create a new paradigm in the gaming industry.

💡 CryptoKitties: A blockchain-based digital collection game where players can buy and sell cats using the Ethereum network.
💡 Axie Infinity: A blockchain-based game where players collect digital creatures called Axies and earn rewards through battles.

Conclusion

In our daily lives, services we use every day, such as portal sites, social media platforms, and messaging apps, rely on server programs to operate. This indicates that there are many environments where smart contracts can be implemented. Can you feel the changes that smart contracts might bring to our lives in the future?

While there are still many challenges to overcome before smart contracts can fully replace existing systems in our society, there's no doubt that they have the potential to drive significant innovation. We recommend keeping a close eye on how smart contracts are applied across various fields in the future.

[reference]
- https://ethereum.org/smart-contracts/#use-cases
- https://academy.dcentwallet.com/blockchain-basic/what-is-a-smart-contract
- https://github.com/ethereumbook/ethereumbook/blob/develop/07smart-contracts-solidity.asciidoc#what-is-a-smart-contract