What Is a Smart Contract? History, Pros and Cons, Use Cases, and More

Smart contracts are one of the most innovative applications of blockchain technology, enabling the automation and decentralization of various transactions and agreements. But what exactly are smart contracts, how do they work, and what are their benefits and challenges? In this article, we will explore these questions and provide some real-world examples of smart contracts across different industries.

What Is a Smart Contract?

A smart contract is a computer program or a transaction protocol that is intended to automatically execute, control, or document events and actions according to the terms of a contract or an agreement. Smart contracts run on the blockchain, which is a distributed ledger that records and verifies transactions in a secure and transparent way. Smart contracts can be used to facilitate the exchange of value, such as money, property, or data, without the need for a central authority, legal system, or external enforcement mechanism.

Smart contracts can be seen as a digital version of traditional contracts, but with some key differences. First, smart contracts are self-executing, meaning that they perform the actions specified in the contract when certain conditions are met. For example, a smart contract can automatically transfer funds from one party to another when a service is delivered or a product is received. Second, smart contracts are immutable, meaning that they cannot be modified or tampered with once they are deployed on the blockchain. This ensures that the contract terms are always respected and enforced. Third, smart contracts are transparent, meaning that they are visible and verifiable by anyone on the network. This enhances trust and accountability among the parties involved.

History of Smart Contracts

The concept of smart contracts was first proposed in 1994 by Nick Szabo, an American computer scientist who also invented a virtual currency called “Bit Gold” in 1998, 10 years before Bitcoin was introduced. Szabo defined smart contracts as “computerized transaction protocols that execute the terms of a contract”. He envisioned that smart contracts could extend the functionality of electronic transaction methods, such as point of sale (POS), to the digital realm.

However, it was not until the advent of blockchain technology that smart contracts became feasible and practical. The first blockchain platform that supported smart contracts was Ethereum, which was launched in 2015 by Vitalik Buterin and Gavin Wood. Ethereum introduced a Turing-complete programming language called Solidity, which allows developers to create and deploy complex smart contracts on the Ethereum network. Since then, many other blockchain platforms have emerged that enable smart contract development, such as Cardano, Solana, Binance Smart Chain, and more.

Pros and Cons of Smart Contracts

Smart contracts offer many advantages over traditional contracts, but they also face some challenges and limitations. Here are some of the pros and cons of smart contracts:

Pros

• Efficiency: Smart contracts can reduce transaction costs and time by eliminating intermediaries, such as lawyers, banks, or brokers, who usually charge fees and cause delays. Smart contracts can also automate repetitive tasks and streamline workflows.
• Security: Smart contracts are encrypted and distributed among nodes on the blockchain network, which makes them resistant to hacking, fraud, or corruption. Smart contracts also ensure data integrity and privacy by preventing unauthorized access or modification.
• Accuracy: Smart contracts can eliminate human errors and misunderstandings by executing the contract terms precisely and consistently. Smart contracts can also reduce disputes and litigation by providing clear and verifiable evidence of contract performance.
• Innovation: Smart contracts can enable new business models and opportunities by creating new ways of exchanging value and collaborating across different domains. Smart contracts can also foster innovation by allowing anyone to create and deploy their own applications on the blockchain.

Cons

• Complexity: Smart contracts can be difficult to design and implement correctly, especially for complex scenarios that involve multiple parties, conditions, or outcomes. Smart contracts also require technical skills and knowledge to understand and use them effectively.
• Rigidity: Smart contracts are immutable once they are deployed on the blockchain, which means that they cannot be changed or updated easily if there are errors or changes in circumstances. Smart contracts also lack flexibility to accommodate unforeseen events or exceptions that may require human intervention or negotiation.
• Regulation: Smart contracts are not legally recognized or regulated in most jurisdictions, which means that they may not have legal validity or enforceability in case of disputes or conflicts. Smart contracts also pose regulatory challenges in terms of compliance with existing laws and standards that may vary across different countries or sectors.

Use Cases of Smart Contracts

Smart contracts can be applied to various fields and industries that require trustless and transparent transactions and agreements. Some examples of smart contract use cases are:

• Finance: Smart contracts can enable decentralized finance (DeFi) applications that provide financial services such as lending, borrowing, trading, investing, and insurance without intermediaries or centralized control. For example, MakerDAO is a DeFi platform that allows users to create and manage a stablecoin called DAI using smart contracts.
• Supply Chain: Smart contracts can improve supply chain management by tracking and verifying the movement of goods and services along the value chain. Smart contracts can also automate payments and incentives based on the delivery and quality of the products or services. For example, VeChain is a blockchain platform that uses smart contracts to provide traceability and authentication solutions for various industries, such as food, luxury, and healthcare.
• Healthcare: Smart contracts can enhance healthcare delivery and research by facilitating the sharing and protection of medical data and records. Smart contracts can also automate clinical trials and drug development processes by enforcing protocols and consent agreements. For example, Medicalchain is a blockchain platform that uses smart contracts to enable patients to securely store and share their health records with doctors and other providers.
• Real Estate: Smart contracts can simplify real estate transactions by automating the transfer of property titles and payments. Smart contracts can also enable crowdfunding and fractional ownership of real estate assets by issuing tokens that represent shares of the property. For example, Propy is a blockchain platform that uses smart contracts to facilitate cross-border real estate deals and eliminate fraud and intermediaries.
• Identity Management: Smart contracts can empower users to create and control their own digital identities and credentials without relying on third-party authorities or platforms. Smart contracts can also enable users to verify and share their identity information selectively and securely with other parties. For example, Civic is a blockchain platform that uses smart contracts to provide identity verification and protection services for individuals and businesses.

Real-world Use Case of Smart Contracts

One compelling real-world use case of smart contracts is in the realm of insurance claims processing.

Traditionally, when an individual experiences an event covered by their insurance policy, such as a car accident or property damage, they must go through a time-consuming and often frustrating claims process. This typically involves filing paperwork, providing evidence, and waiting for the insurance company to assess the claim, which can take weeks or even months.

Smart contracts streamline this process dramatically. Here’s how it works:

1. Policy Setup: When an individual purchases an insurance policy, a corresponding smart contract is created on the blockchain. The terms and conditions of the policy are encoded into the contract.
2. Event Trigger: When an insurable event occurs, such as a car accident, IoT devices, or trusted data sources can automatically trigger the smart contract. For instance, a GPS sensor in the car could detect a collision and send the data to the contract.
3. Claim Verification: The smart contract automatically verifies the event against the predefined conditions in the policy. If the conditions are met, it initiates the claims process.
4. Automatic Payout: Rather than waiting for a claims adjuster to assess the damage, the smart contract can calculate the payout amount based on the policy terms and the verified event. It then disburses the funds directly to the policyholder’s wallet.

This use case not only reduces the time and hassle of claims processing but also minimizes the potential for disputes and fraud. It’s a prime example of how smart contracts can bring efficiency and transparency to traditional processes, benefiting both insurers and policyholders.

Smart contract code example solidity

Below is a simplified example of a smart contract written in Solidity for an insurance claims processing scenario. This smart contract handles the process of filing a claim, verifying it, and approving a payout.

// SPDX-License-Identifier: MIT
pragma solidity ^0.8.0;

contract InsuranceClaim {

    address public insurer; // Address of the insurance company
    address public policyholder; // Address of the policyholder
    uint256 public claimAmount; // Amount to be claimed
    bool public isClaimApproved; // Status of claim approval

    // Events to log the key contract actions
    event ClaimFiled(address indexed policyholder, uint256 claimAmount);
    event ClaimApproved(address indexed insurer, uint256 claimAmount);

    // Constructor initializes the contract with insurer's address
    constructor(address _insurer) {
        insurer = _insurer;
    }

    // Function for the policyholder to file a claim
    function fileClaim(uint256 _claimAmount) public {
        require(msg.sender == policyholder, "Only the policyholder can file a claim");
        require(_claimAmount > 0, "Claim amount must be greater than zero");

        claimAmount = _claimAmount;
        emit ClaimFiled(msg.sender, claimAmount);
    }

    // Function for the insurer to approve the claim
    function approveClaim() public {
        require(msg.sender == insurer, "Only the insurer can approve claims");
        require(claimAmount > 0, "No claim has been filed");

        isClaimApproved = true;
        emit ClaimApproved(msg.sender, claimAmount);
    }
}

Here’s what this Solidity smart contract does with comments:

1. Declare the contract with two state variables, insurer and policyholder, representing the addresses of the insurance company and the policyholder, respectively.
2. Define the claimAmount variable to store the amount of the claim and isClaimApproved to track whether the claim is approved or not.
3. Emit two events: ClaimFiled to log when a policyholder files a claim and ClaimApproved to log when the insurer approves a claim.
4. In the constructor, set the insurer address when deploying the contract.
5. Create a function fileClaim for policyholders to file a claim. It checks that only the policyholder can file and that the claim amount is greater than zero.
6. Implement a function approveClaim for the insurer to approve the claim. It checks that only the insurer can approve and that a claim has been filed.

This simplified smart contract illustrates the fundamental aspects of an insurance claims processing system on the Ethereum blockchain. In practice, such contracts would be more complex and involve additional features for handling payouts, multiple claims, and possibly oracles to verify real-world events like accidents.

Conclusion

Smart contracts are a powerful technology that can revolutionize the way we create and execute contracts in the digital age. By leveraging the features of blockchain, such as decentralization, security, and transparency, smart contracts can offer efficiency, accuracy, and innovation for various transactions and agreements across different domains. However, smart contracts also face some challenges and limitations, such as complexity, rigidity, and regulation, that need to be addressed and overcome to achieve mass adoption. Therefore, it is important to keep up with the latest developments and trends in smart contract technology and explore its potential applications and implications for the future.