How ethereum smart contracts work
Although the media often focuses on the price movements surrounding cryptocurrency, they've missed the most important point — how the technology has revolutionized multiple industries.
Attending any ethereum event these days, you'll find no doom and gloom among participants. And their enthusiasm stems predominantly from the fact that the ethereum blockchain brought with it the potentially game-changing technology of smart contracts.
What are smart contracts?
A smart contract is a collection of code that runs on the ethereum blockchain. It has an address and can handle transactions. When sending a transaction to the smart contract, its code handles the functionality and no human interaction is required.
Why are smart contracts useful?
All technology has limits, even groundbreaking technology. Smart contracts were conceived as a way to maximize the potential of a blockchain by adding a layer of programmability. Specifically, smart contracts allow us to write code that executes onto a blockchain.
Blockchain is a technology that allows for immutable storage of transactional data across a decentralized network. That transactional data could be the transfer of value such as bitcoin or ether (ETH), or it could be the transfer of information such as web browsing data.
Cryptocurrencies only exist on a blockchain. Think of blockchain as the rails and cryptocurrency as the train on those rails.
The bitcoin blockchain was the first widely used blockchain for cryptocurrency, but it is limited in programming functionality. It allows for storing bitcoin transactions and data, and nothing else.
That changed when the ethereum blockchain was developed. The ethereum blockchain follows the same general principles as all blockchains, but it introduced something previously unheard of: smart contracts.
What are the benefits of smart contracts?
Smart contracts have endless use cases because they can handle any form of data, not only cryptocurrency data. But let's start with cryptocurrency. A smart contract can be programmed to:
- Hold funds in escrow until a specified condition in the contract is met. That condition is coded into the contract, so there is no way for humans to avoid fulfilling the contractual obligation.
- Convert one token (cryptocurrency coin) into another.
- Handle lending and borrowing automatically.
- Automatically exchange tokens when certain market conditions are met.
Outside of cryptocurrency, developers are experimenting with everyday use cases for smart contracts, such as supply chain management and data authentication. Smart contracts can be thought of as a new form of computer programming that:
- Must meet certain criteria to function successfully. If those conditions are not met, the smart contract does not run at all.
- Removes intermediaries.
- Can operate autonomously.
In short, the ethereum ecosystem and its smart contracts brought with it the opportunity to create fully-fledged applications on a blockchain. Today, many tech companies have started experimenting in blockchain and smart contract technology.
It was the smart contract that increased ethereum's popularity so much that its cryptocurrency (ETH) became the second-most valuable in the world, second only to bitcoin. And the ethereum blockchain opened the door for bitcoin to interact with other blockchains.
Decentralized finance (DeFi) and smart contracts
Smart contracts also gave rise to one of the most interesting aspects of blockchain technology which is decentralized finance. By creating automated programs (smart contracts) that can automatically handle transactions according to programmatic rules, developers have attempted to bypass intermediaries for money market services.
Suddenly, entities that had no owner could accept money, loan it out, collect interest, raise collateral, and basically provide all the functions that banks have typically provided over the centuries, but without the middleman fees.
This technology was called decentralized finance because it had no central location from which it operated. The applications that managed the services were called dapps — decentralized apps — which were deployed onto the ethereum blockchain and then run all by themselves.
Decentralized exchanges (DEXs) allow you to buy crypto directly peer-to-peer without the involvement of a central intermediary. Suddenly, anyone anywhere could buy and sell crypto.
The advent of DEXs and the broader DeFi ecosystem stands in contrast to the traditional banking system and its associated regulatory framework. For instance, in banking, you have to know who is making what transaction and with whom. It's called KYC — Know Your Customer — and is one of the core regulations of any banking service.
KYC is a mandatory framework for any regulated financial institution to identify its users. When opening an account, KYC procedures require the new account holder to typically provide information, such as a photo ID coupled with a selfie, and other personal details to determine who is opening the account. This prevents entities on sanction lists or other criminal elements from opening accounts that they could use for the illicit transfer of funds. It also reduces the potential for identity theft and credit card fraud.
DEXs don't generally impose any sort of KYC checks because they are not financial institutions. They are a set of code routines (smart contracts) that facilitate direct financial transactions between users. In this sense, DeFi has been a regulatory challenge because criminals could open any number of accounts and use those accounts to embezzle funds.
While the implications of DeFi will likely be the subject of intense debate in government circles for years to come, the concept illustrates the potential of smart contracts as a new, disruptive technology.
Smart contracts help Casa secure your ETH
It is because of the smart contract that Casa is now able to secure your ETH in a similar manner to how we secure your bitcoin, using a multisig protocol.
Doing this for bitcoin was easy because bitcoin supports multisig locking natively. But ethereum doesn't. Enter smart contracts.
As our co-founder and CTO recently pointed out in a blog post about how Casa's ethereum wallet will work, Casa is not in the business of creating smart contracts. And we consider the security of our clients' funds our top priority, so we will be using an existing "battle-hardened" smart contract that is currently being used to secure billions of dollars on the ethereum blockchain.
And again in this use case, the smart contract shows its flexibility and almost limitless potential for ingenuity.
Regardless of what happens to the price of bitcoin or ethereum, the world of crypto assets is here to stay because of the smart contract and other technology and the doors it continues to open.
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Smart Contract FAQs
What language does ethereum use to write smart contracts?
What are the steps to building smart contracts?
To create and deploy smart contracts, you need to download a development environment that allows you to upload a tested version of your smart contract to the ethereum network.
What are some use cases for smart contracts?
Smart contracts can be used for anything that requires a contractual agreement between two parties. Smart contract usage is being explored in applications from banking to supply chains to insurance.