A smart contract is a programmable contract that allows two counter-parties to set conditions of a transaction without the need for a central authority or an intermediary for the execution.
The purpose is to simplify business and trade between both anonymous and identified parties without the need for a 3rd party.
Smart contracts eliminate the need for unnecessary documentation and costly intermediary to facilitate the transaction while maintaining absolute visibility through blockchain transparency.
What Are Smart Contracts Used For?
- Lending protocols
- Dex – decentralised exchanges
- Digital asset transfers (such as NFT)
What is the Role of Smart Contracts in DeFi?
The DeFi movement has grown from a small community in 2018 to one of the fastest developing industries in 2021.
Many Decentralized applications (dApps) work by utilizing smart contracts to support the trading of products, services, data, funds, etc.
DApps have to leverage smart contracts to make sure that every transaction on the blockchain is valid and transparent… and that the executions are being transferred accordingly with the predefined provisions of the agreement.
Smart contracts work on the “if this, then that” principle. Whenever a certain condition is fulfilled, the smart contract will carry out the operation as programmed.
An Example of a Simple Smart Contract in Action…
Mary wants to set up a trust fund to pay Henry $10 at the first of every month for the next 12 months, she can program a smart contract to:
- Check the current date
- At the start of each month, send Henry $10 automatically
- Repeat until the fund in the smart contract is exhausted
By utilizing a smart contract, Mary has bypassed the need to have a trusted third-party intermediary (lawyers, escrow services, etc.) to send the trust fund to Henry and made the process transparent to all involved parties.
More complex processes involve multiple smart contracts to operate with each other simultaneously which happened in most Decentralized applications (dApps).
What Are the 4 Advantages of Using Smart Contracts?
The top 4 advantages of smart contracts, as opposed to centralized and conventional methods, are:
- Trust: Your contracts and documents are encrypted on a shared ledger. No one can tell you they lost it.
- Transparency: Visible for all parties to precisely see how each application behaves
- Speed & Cost: Much quicker – and cheaper – to execute without the need to go through undue paperworks and documents
- Precision: Preprogrammed codes can execute the contract more accurately than most 3rd parties which involved human-related-flaws
Top 4 Use Cases of Smart Contracts
There are several use cases, varying from conventional financial structures, such as transfers, to modern instruments, like tokenization and stable-coins, that have emerged due to the functionality of decentralized ledgers (tokens that are connected to a fiat currency, like dollars).
These are the 4 most popular ones:
1. P2P Payments and Transactions
With distributed ledger technology (DLT), there is no need for third parties or intermediaries such as financial institutions and agents.
There is an upward trend for peer-to-peer cryptocurrency payments (P2P), especially for cross-border transactions, where the costs and the time it takes hinder both the sender and receiver when using traditional methods.
2. Digital Identity
Many people in Africa are without an identity, providing decentralized digital ID can open up access to banking, education, and healthcare which enables Africa to achieve its goal of an inclusive and integrated digital economy.
Atala Prism (built on the Cardano blockchain) is a decentralized identity solution that aims to bring digital identity to millions over the world without the need of issuing identification cards and physical passports.
The truth is, there are tons of unlawful cases such as illegal money lending and blackmailing which involved lost identification cards.
Lost passports can also cause undue distress and inconvenience when traveling.
With a digital identity, everything is stored safely on the blockchain… you do not have to worry about ever losing your ID again.
Digital ID can also be used to store records of your:
- Civil records
- Health records
- Driving licenses
- Education certificates
- Asset ownership
- Club/gym memberships
- And many others…
3. Digital Marketplace
Digital marketplaces such as OpenSea and CNFT allow investors to participate in the world of NFT by allowing buyers and sellers to connect without having to deal with brokerage firms like Amazon or eBay.
The possibility for disruption is not confined to the art and NFT world; services such as Upwork and Fiverr are seeing blockchain rivals emerge, such as Anytask. Since they pay in tokens, they don’t charge vendors a percentage of their fee and may help the unbanked in developing countries.
4. Borrowing and Lending
Many investors cannot obtain funds due to strict credit regulations, which require protection in the form of collateral.
Borrowers who may not qualify for a loan from a conventional bank may use DLT to freely access funds from one or more investors, with the loan defined and monitored by a smart contract.
Another form of lending and borrowing involves projects such as BlockFi, Celsius, and Salt which lend against crypto collateral and pay interest on your deposit that are way higher than most conventional banks.
What is the Risk of Using a Smart Contract?
- The sector is still at its infant stage with inadequate cybersecurity to defend against hacking
- Wrong contract structuring due to inaccuracies or bugs in the code
- No changing your mind once the contract is executed, it performs regardless if you make a mistake
Autonomy is an advantage of using smart contracts but having absolute autonomy is also a risk…
You are the one making the decision yourself without an experienced broker or lawyer to confirm the transaction for you… sometimes, this could spell trouble.
It is also worth noting that currently, no regulations are governing smart contracts.
Therefore, extra care should be taken at all times…
If you face uncertainties or have doubts, err to the safe side and never send a code until you know absolutely what you are signing up for.