<p>A few months ago, the crypto world was has been shocked by the Wormhole platform hack. $325m is the total amount of damage. The cause was confirmed to be an error in the smart contract coding on Github. So what are smart contracts and why do they appear in nearly all DeFi projects? Let’s find out on <a href="https://www.builder.news/" alt="Builder.news" title="Builder.news" target="_blank" rel="" class="">Builder.news</a>.</p><h2>What is a smart contract?</h2><p>Smart contracts are simply programs that run when certain criteria are satisfied and are stored on a blockchain. Smart contracts, which are self-automating contracts with stipulations put into code, are at the heart of a blockchain-based ecosystem. They are in charge of carrying out all transactions on a blockchain network.</p><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed0973c707d879a8e6023f659fee92.jpg" alt="Smart contracts" title="Smart contracts" width="600" height="401"></p><p>Smart contracts, as opposed to traditional paper-based contracts, begin and execute the transactions agreed upon by the parties without the need for human intervention. They enable enterprises to create immutable and accessible agreements while reducing the formality and expenses associated with traditional contracts.</p><h2>Mechanism of smart contracts</h2><p>To get the best understanding of how a smart contract works, let’s turn back the clock and meet the father of the term - Nick Szabo.</p><p>Nick Szabo, a computer scientist, and a cryptographer created the term in 1994. In one of his research, he used the well-known example of a vending machine to explain the mechanics of a smart contract. When the purchaser inserts money into the machine (meeting the contract's terms), the machine automatically honors the agreement and distributes the snack and remaining change. Smart contracts, like vending machines, may automate any type of exchange without the need for a human middleman.</p><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed0973c707e210a8e6023f659fee92.jpg" alt="smart contracts building blocks" title="Smart Contracts Building Blocks for Digital markets" width="600" height="267"></p><p class="prosemirror-p-center"><em>Source: Nick Szabo.</em></p><p>If you do know a bit of coding, you know the <em>“If.. Then..”</em> and <em>“If..Else..”</em> statements. Smart contracts operate using these simple statements which control transactions. These contracts immediately run the code once the predetermined conditions of the agreement are met and validated. This code is duplicated across the decentralized blockchain network's nodes. These acts can take many different forms, such as distributing funds, delivering notifications, or issuing a penalty. The whole process is like this:</p><ul><li><p>First, there are two parties: A buyer and a seller who are both interested in purchasing and selling an asset.</p></li><li><p>These two parties enter into a smart contract, which is a completely digital and self-executing agreement with conditions or clauses recorded in code on a decentralized blockchain network.</p></li><li><p>These codes define the terms of the agreement, which both parties must agree to in order for the contract to be automatically enforced. When the parties follow these criteria and rules, the transaction takes place.</p></li><li><p>The smart contracts platform offers complete transparency and high-end security. Also, it restricts tampering with the data and allows the two parties to track the transaction. The identities of the parties involved, however, remain confidential.</p></li></ul><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed0973c707e83ba8e6023f659fee92.jpg" alt="Smart contracts functioning" title="Smart contracts functioning" width="600" height="379"></p><p class="prosemirror-p-center"><em>Source: Wallstreet Mojo</em></p><h2>Types of smart contracts</h2><p>Considering their applications in the blockchain world, smart contracts diversify into three main groups:</p><h3>Application logic contracts</h3><p>ALCs, or Application Logic Contracts, include application-based code that is in sync with other blockchain contracts. They allow communication between diverse devices, such as the Internet of Things (IoT) and blockchain technology. ALCs are a critical component of multi-function smart contracts that are often managed by a computer.</p><h3>Decentralized autonomous organization (DAO)</h3><p>DAOs, or Decentralized Autonomous Organizations, are communities that live on the blockchain. These communities can be defined by a set of mutually agreed-upon rules that are coded using smart contracts. Every person and their acts are subject to the community's rules, which must be enforced. These rules are made up of numerous smart contracts that work together to monitor community actions.</p><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed099864e5bab7a8e6023f659fee92.jpg" alt="DAOs use cases" title="Use cases of DAOs" width="600" height="400" class="lykafe3"></p><h3>Smart legal contract</h3><p>A smart legal contract, the most common type of smart contract, involves similar legal requirements to its traditional counterpart (i.e., mutual assent expressed by a valid offer and acceptance; adequate consideration; capacity; and legality), and it is put in place to hold concerned parties accountable for fulfilling their end of an agreement. When correctly set up, a smart contract is legally enforceable and requires the parties to meet their responsibilities; failure to fulfill obligations in the contract may result in legal action against the party in breach, which can be immediately triggered by the smart contract.</p><h2>Use cases of smart contracts</h2><h3>Decentralized Finance</h3><p>Smart contracts are used in nearly all dApps. Decentralized finance (DeFi) dApps are a strong alternative to traditional financial services, and their popularity is growing as a result of blockchain and smart contract technology's trustless, immutable, and transparent qualities.</p><p>DeFi dApps offer complementary services to the banking and financial services industries, such as lending, borrowing, trading, and a variety of other financial services, as well as entirely new types of products and decentralized business models that can provide significant benefit and utility to users. With smart contracts' improved transparency (combined with 24/7 functioning and lower prices), dApps have the potential to lower the barriers to entry into the financial services industry for people all over the world.</p><p>DeFi projects have already captured billions of dollars in market cap and are expected to continue this trend as more individuals become acquainted with the sector's unique value propositions. Users can use this new generation of financial services without requiring centralized custody or paying intermediary costs.</p><p>Although the <a href="https://www.builder.news/sub-category/defi" alt="DeFi category on Builder.news" title="DeFi category on Builder.news" target="_blank" rel="" class="">DeFi sector</a> is still in its early stages, the implications of smart-contract-powered dApps on the financial industry are already being felt, given the number of creative dApps that are currently offering value and utility to users.</p><h3>Securities trading</h3><p>Securities trading is one groundbreaking application of smart contracts. Handling stock shares used to entail a lot of paperwork and some trusted middlemen. Most transactions are still done on paper today: for example, if you want to sell your stocks, you contact a broker and put an order. Shares are transferred electronically, although there may be a wait while your broker confirms this with another business.</p><p>Smart contracts can help us removes brokers from the trade process, decreases transaction costs, and allows for immediate processing because deals are executed concurrently on numerous competing nodes rather than sequentially through a central broker.</p><h3>Lending market</h3><p>Smart contracts enable an automatic registration process. They help improve borrower/lender matching, lower transaction costs as compared to traditional marketplaces, and more effective capital allocation due to funds not being held up through lengthy registration processes. For instance, a borrower could sign one contract that automatically searches the network for lenders, while another contract records all loan arrangement details.</p><p><em><strong>&gt;&gt;&gt; Read more:&nbsp;</strong></em><a href="https://www.builder.news/crypto-insights/idle-money-for-defi-lending-and-staking-what-you-need-to-know" alt="Idle money for DeFi lending and staking - What you need to know" title="Idle money for DeFi lending and staking - What you need to know" target="_blank" rel="" class=""><em><strong>Idle money for DeFi lending and staking - What you need to know</strong></em></a></p><h3>Non-Fungible Token (NFT)</h3><p>Permanent identity information is made feasible via smart contracts. They also prevent NFTs from being separated into smaller components for sale.</p><p>Furthermore, the smart contract can assure that the digital assets are unique and unreplicable. This makes <a href="https://www.builder.news/sub-category/nft" alt="NFT category on Builder.news" title="NFT category on Builder.news" target="_blank" rel="" class="">NFTs</a> scarce and rare, which is why they are valuable. On the blockchain, virtually anything may be represented digitally.</p><h3>Transparent voting</h3><p>Civic was among the first to suggest employing blockchain technology for digital voting systems. The objective is to replace insecure, expensive, and time-consuming paper-based voting systems with a safe system based on Ethereum smart contracts and biometric identification capabilities.</p><p>Smart contract-based votings are cheaper than traditional paper-based balloting. They have greater transparency because all votes are recorded on a public ledger shared among participants. Smart contracts increase security because access is carefully authenticated using biometric identification tools, and records cannot be altered once they are registered on the blockchain.</p><h2>Smart contracts: Pros and Cons</h2><p>Everything in this world has its upside and downsides. Although smart contracts are a breakthrough in the blockchain industry, they are not an exception.</p><table><tbody><tr><td data-colwidth="336" style="background-color: #f9cf2e;"><p class="prosemirror-p-center"><strong>Smart contract Pros</strong></p></td><td data-colwidth="360" style="background-color: #f9cf2e;"><p class="prosemirror-p-center"><strong>Smart contract Cons</strong></p></td></tr><tr><td data-colwidth="336" style="background-color: [object Object];"><ul><li><p>Transparency: visible, unchangeable information to everyone.</p></li><li><p>Security: Blockchain transaction records are difficult to compromise due to their encryption.</p></li><li><p>Efficency and precision: since they are self-executing, smart contracts save the time spent on paperwork and resolving errors.</p></li><li><p>Savings on expenses: Smart contracts eliminate the need for financial intermediaries to oversee transactions, reducing time delays and service fees.</p></li><li><p>High level of composability: Composability refers to the ability of single-system components to be altered and integrated into larger frameworks and procedures.</p></li></ul></td><td data-colwidth="360" style="background-color: [object Object];"><ul><li><p>Complex language: the complexity of programming languages keeps them out of reach for many.</p></li><li><p>Liability: Regulatory frameworks for establishing and running smart contracts are still in their infancy due to a lack of intermediaries.</p></li><li><p>High-staked flaw: Any flaws in smart contracts might lead to costly blunders and the loss of the parties' assets.</p></li><li><p>Legal problems: Blockchain and smart contracts are not yet common concepts, and a court may have difficulty resolving issues involving them.</p></li><li><p>Loopholes: implementing smart contracts makes it impossible to ensure that the terms agreed upon are met.</p></li></ul></td></tr></tbody></table><p><em>The third weakness refers to smart contract exploits. Hackers usually find errors in the coding of the targeted smart contracts and attack them. For instance, a hacker exploited a Poly Network smart contract vulnerability in August 2021. This is one of the biggest DeFi hacks that ever happen when he managed to steal $600m in total. Catastrophic as the exploits were, I still don’t think they are too much of a problem since they rarely happen. Considering the enormous benefits that smart contracts bring, the pros seem to outweigh the cons.</em></p><p class="prosemirror-p-center"><img src="https://cdn.builder.news/news/11ed0973c707ed98a8e6023f659fee92.jpg" alt="smart contract" title="Smart contract" width="600" height="400"></p><h2>Conclusions</h2><p>Smart contracts are certainly helpful, despite their hazards. They save billions of dollars in indirect costs while substantially boosting system efficiency. Smart contract audits have also been devised and implemented to assure the code's dependability and durability. Although they require considerable development before widespread acceptance, particularly in complex corporate agreements and relationships, these contracts have the potential to fundamentally alter society's approach to contracts.</p><p>They are now used more and more in real-world fields such as legal agreements, real estate, and retail.</p><p class="prosemirror-p-right"><em><strong>Written by Blue Pine</strong></em></p><div class="pr-block-special"><strong>Disclaimer:</strong><br>This article is intended for and only to be used for reference purposes only. No such information provided constitutes advice or a recommendation that any investment or trading strategy is suitable for any specific name.</div>

This article shows you how smart contracts work, and what are the pros and cons of using a smart contract from the perspective of the writer.

Blockchain's backbone to call Smart Contracts