What is a smart contract?
The blockchain ecosystem employs smart contracts as programs that execute when specific conditions are met and are maintained on a blockchain. Smart contracts automate agreements, allowing all parties to reach decisions without intermediaries or delays. Smart contracts can also automate workflows triggered by certain conditions.
The coding of “if/when…then…” statements on a blockchain enables smart contracts to operate. A network of computers verifies and executes the activities when predetermined conditions are met, such as transferring payments, issuing tickets, or registering a vehicle. When the transaction is complete, the blockchain is updated and is immutable. Only those granted access can view the results.
Ethereum (ETH) is the most common blockchain for executing automated agreements. Smart contracts on Ethereum are typically coded in Solidity, a Turing-complete programming language, and then compiled into low-level bytecode that can be executed by the Ethereum Virtual Machine.
Polkadot, developed by Gavin Wood, one of Ethereum’s co-founders, is another smart contract ecosystem. Wood launched his blockchain network after recognizing that ETH has not yet realized its potential as a secure and scalable system.
Smart contracts are used in a variety of financial applications, such as trading, investing, lending, and borrowing. They can also be applied in numerous other industries, including healthcare, gaming, and real estate, as well as for constructing entire business structures.
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What provides the foundation for DeFi smart contracts?
Decentralized smart contracts are built on two key technologies: distributed ledgers and cryptocurrencies.
The data within these smart contracts must be securely stored in a digital ledger, with the order and content of transactions preserved. In a blockchain, individual transactions are grouped into blocks, which are then arranged sequentially to form the ledger.
Cryptocurrencies like Bitcoin are an example of a virtual currency that is traded and developed on digital platforms. The European Central Bank has described it as an “unregulated, decentralized, digital crypto-currency.” In the past, efforts to establish digital currencies required the use of a bank to maintain the ledger of ownership accounts.
However, with the development of blockchain technology, this ledger can now be disseminated across a peer-to-peer network, maintaining the integrity of the transaction log without the need for a centralized authority. As a result, decentralized cryptocurrency marketplaces can now exist.
What are the different stages in the life cycle of smart contracts?
The life cycle of a smart contract involves four main phases: creation, freezing, execution, and finalization. Unlike the blockchain development life cycle, which starts with defining the problem and ends with a minimum viable product, the creation phase of a smart contract involves iterative contract negotiation and implementation.
Creation phase
During the creation phase, the parties agree on the contract’s content and goals and then convert it into code. The smart contract coding language’s expressiveness limits the contract’s codification, and most smart contract systems provide infrastructure to build, maintain, and test smart contracts.
The negotiation and implementation phases may require several iterations to transition the requirements into code, similar to traditional programming languages. After agreeing on the codified form of the contract, the contract is uploaded to the distributed ledger during the publication phase. Once most nodes have confirmed the block, the contract is available for execution. It’s worth noting that any changes to the smart contract will require the development of a new contract because decentralized smart contracts can’t be amended once the blockchain accepts them.
Although a smart contract is placed on the blockchain, it doesn’t imply an agreement to enter the contract, as anyone can submit a smart contract to the blockchain. Similarly, decentralized smart contracts can benefit any blockchain participant, whether or not they choose to receive the benefits in advance.
Freezing phase
In the freeze phase, the contract is confirmed by a majority of nodes, and any transfers to the contract’s wallet address are blocked. Nodes verify that the contract’s preconditions for execution are met, and they operate as a governance board during this phase.
Execution phase
In the execute phase, the smart contract is executed by the smart contract environment’s inference engine. The contract’s integrity is verified, and its functions are conducted when inputs are received from smart oracles and involved parties. The execution generates a new set of transactions and a new state for the smart contract, which are entered into the distributed ledger and verified using the consensus mechanism.
Finalization phase
Finally, in the finalize phase, the resulting transactions and updated state information are confirmed using the consensus process. The previously committed digital assets are transferred, and the contract is completed to confirm all transactions.
The process of smart contracts in the blockchain ecosystem can be divided into several stages, starting from the contract creation to execution and completion:
The first stage is the contract creation, where the terms and conditions of the contract are written in code by a developer. These terms and conditions are encoded in the contract and are stored on the blockchain.
The second stage is the deployment of the contract, where the contract is uploaded to the blockchain network. Once the contract is deployed, it can be accessed by anyone on the network, and its code becomes immutable and tamper-proof.
The third stage is the execution of the contract, where the conditions of the contract are verified and enforced by the network. This is done through the consensus mechanism of the blockchain, which ensures that all nodes on the network agree on the state of the contract.
The fourth stage is the completion of the contract, which occurs when all the conditions of the contract are met. At this stage, the contract is closed, and its results are recorded on the blockchain.
After the completion of the contract, it remains on the blockchain indefinitely, providing a transparent and immutable record of the transaction. This makes it possible to track the contract’s history and ensure that it was executed as intended.
Smart contracts are a powerful tool in the blockchain ecosystem, allowing for secure, automated, and trustless transactions. They have the potential to revolutionize various industries, from finance to real estate, and their use is only expected to grow in the coming years.
The life cycle of a smart contract has its advantages and disadvantages.
On the positive side, the creation phase allows for easy and quick agreement on contract content and goals, and the code is easy to execute. The publication phase ensures that the contract is tamper-proof and transparent, and that it can only be changed through a new smart contract. The freeze phase helps to ensure that the preconditions for executing the contract are met, and the execute phase executes the contract automatically and autonomously, ensuring that all parties receive the expected results. Finally, the finalize phase provides clarity and transparency to all parties and ensures that digital assets are transferred as per the contract terms.
On the negative side, creating a smart contract requires technical skills, which can be a barrier to entry for some parties. The implementation phase may also involve multiple iterations, leading to delays and increased costs. The fact that smart contracts cannot be amended once submitted can be a disadvantage if there are errors or unforeseen events that require changes to the contract terms. Additionally, the fees paid to miners to confirm the contract can be high and add to the cost of executing the contract.
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Can a smart contract be terminated?
Smart contracts can be destroyed using the selfdestruct function, which is available in Ethereum smart contracts. However, using this function comes with both benefits and drawbacks for developers.
On the one hand, the selfdestruct function can be used to delete smart contracts and transfer Ether in the event of an emergency, such as an attack. This can be a useful tool for developers to protect their assets.
On the other hand, the selfdestruct function can add complexity to the development process and also provide an attack vector for malicious actors. Additionally, because smart contracts are immutable, once destroyed, they cannot be recovered or restored.
When security flaws or errors are discovered in a smart contract, developers can use the selfdestruct function to kill the contract and create a new version with the necessary upgrades or fixes. This can help ensure the ongoing security and functionality of the smart contract.
The infamous 2016 DAO attack is an example of the potential risks associated with smart contract vulnerabilities. The DAO organization lost millions of dollars in Ether due to a vulnerability called Reentrancy in their smart contract. Because the contract did not have a self-destruct function, the organization was unable to stop the attack or move the Ether to a secure location. If a self-destruct function had been included, the organization could have quickly transferred the Ether and potentially avoided significant financial damage.
