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Understanding Smart Contracts: a practical guide

There have been a lot of inventions over the course of history that revolutionised the way people handle their business processes. From clay tablets in Mesopotamia as early as 9000 BCE to paper in China at about 100 CE all the way to computers in the second half of the 20th century. What is the next thing that would make us rethink our ways and raise the bar for speed, efficiency and security? I daresay that blockchain-based smart contracts are the new milestone. Their potential, first revealed only a couple of decades ago, is yet to be discovered in its entirety. However, it is already a booming industry, its products being fully appreciated by governments, the finance, gaming as well as healthcare, insurance and so on. As you will see, practically any sector can benefit from smart contracts, so now may be the perfect time to think about implementing them in your business. This article will provide you with a guide into the smart contract universe, including a practical part that would help you find the right solution for you. Let’s get started!

You can the use of smart contracts in various industries here.

The basics

 

Smart contracts run on blockchain technology and thus are primarily associated with blockchain platforms like Ethereum. These platforms use decentralised, distributed ledgers to ensure transparency and security. Once deployed, smart contracts execute automatically when predefined conditions are met. This eliminates the need for intermediaries, reducing the risk of fraud and errors. Smart contracts can be used to create and manage digital tokens, representing assets like cryptocurrencies, real estate, or even shares in a company. These tokens can be transferred and traded in a secure and transparent manner. The very history of smart contracts and blockchain started with the idea of cryptocurrencies:

 

  • 1980s: The conceptual roots of smart contracts can be traced back to the work of computer scientist and cryptographer David Chaum, who introduced the idea of digital cash and electronic contracts.

  • 1994: Nick Szabo, a computer scientist, introduced the concept of smart contracts. He defined smart contracts as computerised protocols that execute the terms of a contract.

  • 2009: Bitcoin Introduction. While Bitcoin primarily focused on peer-to-peer electronic cash, its underlying blockchain technology laid the groundwork for decentralised systems and programmable contracts.

  • 2013: Vitalik Buterin proposed Ethereum, a blockchain platform designed to support smart contracts and decentralised applications (DApps). Ethereum introduced the concept of Turing-complete scripting language for smart contracts.

  • 2015: Ethereum went live, marking a significant milestone in the development of smart contract technology. This allowed developers to create and deploy decentralised applications.

  • 2016: The Decentralised Autonomous Organization (DAO) raised significant funds on the Ethereum platform but suffered a critical vulnerability. Exploiting this flaw led to a contentious hard fork, resulting in the split between Ethereum (ETH) and Ethereum Classic (ETC).

  • 2017: Initial Coin Offerings (ICOs) became a popular fundraising method for blockchain projects. Many of these projects utilised smart contracts to automate token sales.

  • 2018: Smart Contract Auditing. With the growing importance of smart contracts, the need for security audits became apparent. Specialised firms started offering smart contract auditing services to identify vulnerabilities.

  • 2020: Decentralised Finance (DeFi) projects gained traction, leveraging smart contracts to offer financial services like lending, borrowing, and trading without traditional intermediaries.

  • 2021: Non-Fungible Tokens (NFTs) exploded in popularity, utilising smart contracts on platforms like Ethereum to represent ownership of digital assets, leading to a surge in digital art and collectibles.

  • 2022 The industry explored Layer-2 scaling solutions for blockchains, seeking to address scalability issues and reduce transaction costs associated with smart contracts.

 

However, the use of smart contracts is not limited to cryptocurrencies and finance in general. They find applications in various industries, including supply chain management, legal agreements, insurance, and more. They streamline processes, reduce the need for intermediaries and help digitise traditional paperwork that is slow and resource consuming.

 

Governments keep up with innovation

 

The crypto industry started in an attempt to depart from the traditional financial system, considered by many as over-regulated and over-centralised, too conservative and rigid. Also, many of the industry’s founding fathers promoted ideals of freedom on the Internet, away from the ever tightening government control. Even a form of political ideology named “Crypto Anarchy” was created – the term was coined by Steven Levy in his famous longread for the Wired magazine as early as 1993. Ironically, it is the governments that are the primary users of smart contracts, or at least such are the estimates of some researchers. For instance, Zion Market Research states that the government sector held the largest smart contract market share in 2022, with over 36.67% and is expected to retain this role over the years to come. 

 

This is little wonder though. Governments are known to be the biggest paperwork handlers in the world. Also, the data they possess is often very sensible, and the large government systems are sometimes vulnerable to fraud and manipulation. Most government adoption of smart contracts and blockchain gained momentum in the 2010s and has been only spreading since. Estonia has been the pioneer in the adoption of the technology for governance purposes. Its e-Residency program utilises blockchain technology and smart contracts to streamline administrative processes, including company registration, tax filing, and identity verification. Dubai's government has integrated smart contracts into various sectors, including real estate, healthcare, and supply chain management. For example, the Dubai Land Department has implemented blockchain-based smart contracts for property transactions, ensuring transparency and reducing fraud in the real estate sector. 

 

Various state and local governments in the United States have begun experimenting with smart contracts in recent years, exploring a range of applications, such as public procurement, voting systems, and identity management. The Singapore government has been using smart contracts in areas like trade finance, healthcare, and logistics. Georgia's government has implemented blockchain-based smart contracts for land registry and property transactions as one of the key ways to reduce corruption. The Swiss government has utilised smart contracts for various purposes, including digital identity management, supply chain tracking, and intellectual property rights protection. For example, the city of Zug, also known as "Crypto Valley," has implemented blockchain-based smart contracts for citizen ID verification and voting systems. Seoul Metropolitan Government has launched blockchain-based initiatives for document authentication, supply chain management, and citizen services.

 

Mysterious volumes, but undeniable growth

 

Because of their decentralised nature, there is no “major authority” that governs smart contracts and collects reliable statistics. So current market volume estimates vary quite a lot, while mid-term forecasts vary even more. Acumen Research and Consulting estimated the 2022 global smart contract market value at USD 187 million, Allied Market Research at USD 192.7 million. Valuates research company was more generous stating the segment totaled USD 397.8 million in 2022. But even this estimate was shadowed by Zion Market Research, valuing the market at a staggering USD 1.75 billion in 2022, almost an order of magnitude larger than the most modest estimate. 

 

Forecasts are no easy thing either. Acumen estimates smart contract market volume to reach USD 1.417 billion by 2032, Valuates expects almost the same threshold to be hit three years earlier (USD 1.46 billion in 2029), while Allied sets the bar at USD 2.5 billion for 2032. Meanwhile, Contrive Datum Insights has a completely different estimate: USD 8.3 billion by 2030, as does Zion (USD 9.85 billion for the same year). But even as absolute figures may be quite confusing, it is the dynamics of the sector that matters the most. None of the researchers expect the smart contract market to grow at a CAGR below 21% or above 30%. 

 

From theory to practice

 

Now let us proceed to the practical part and compare some of the leading smart contract networks as well as the most promising newcomers of this market:

 

1. Ethereum: has a pioneering track record in smart contracts, hosting thousands of decentralised applications (DApps) and handling a significant portion of the decentralised finance (DeFi) and NFT markets. It generally has a robust security model, but vulnerabilities in smart contracts have led to notable incidents like the DAO hack. Improvements like formal verification are being explored to enhance security. Ethereum faces scalability challenges, resulting in high gas fees and slower transaction speeds during periods of network congestion. Efforts like Ethereum 2.0 aim to improve this. Consequently, the amount of transactions per second (TPS) is the weak point of this network: it is capable of processing around 30 TPS, but the actual rate varies based on network congestion. Gas fees on Ethereum can be volatile and relatively high during periods of high demand. This can pose challenges for users and developers, particularly for small transactions. On the brighter side, Ethereum has a vibrant and extensive developer community, contributing to its rich ecosystem of DApps, DeFi protocols, and tools. Ethereum is widely used for DeFi, non-fungible tokens (NFTs), gaming, decentralised exchanges (DEXs), and various other decentralised applications.

 

2. Binance Smart Chain (BSC): offers better scalability compared to Ethereum, providing faster transaction speeds and lower fees. However, its permissioned nature may impact long-term scalability. BSC can handle up to 100-150 TPS, offering faster and cheaper transactions compared to Ethereum. The network has a growing developer community, benefiting from its compatibility with Ethereum's tooling and its support from the Binance ecosystem. However, BSC has faced criticism for centralization due to its validator set, raising concerns about security and censorship resistance. The network is primarily used for DeFi applications, including decentralised exchanges, yield farming protocols, and other financial services.

 

3. Cardano: its throughput is designed to scale with the number of active stake pools, theoretically capable of thousands of TPS. Cardano aims to provide a more secure and scalable alternative to existing smart contract platforms, with a focus on academic rigour and peer-reviewed research. Transaction costs are competitive, with a focus on affordability and accessibility for users and developers. Cardano's developer community is growing, benefiting from its academic approach and commitment to formal methods in smart contract development. Cardano aims to be a platform for applications across various sectors, including finance, governance, identity management, and supply chain.

 

4. Solana: boasts high throughput, capable of processing over 50,000 TPS, making it one of the fastest blockchain networks. Its architecture emphasises security and scalability, utilising a combination of cryptographic techniques and Byzantine fault tolerance to protect against attacks. Transaction costs on Solana are generally low, providing cost-effective solutions for users and developers, particularly for applications requiring high throughput. Solana has a growing and active developer community, supported by initiatives like the Solana Foundation. Solana is used for a wide range of applications, including DeFi protocols, gaming, NFT marketplaces, decentralised exchanges, and Web3 infrastructure.

 

5. Polkadot: TPS is variable, as it supports multiple parachains connected to its relay chain, enabling horizontal scalability across multiple chains. Polkadot aims to provide enhanced security through its shared security model, enabling parachains to benefit from the security of the relay chain. Its main benefits are interoperability and scalability, attracting projects looking to leverage its ecosystem for cross-chain communication. Transaction costs can vary depending on network activity and congestion, but its scalable architecture aims to maintain cost-effectiveness for users and developers. The network has a growing developer community, supported by initiatives like Web3 Foundation grants and ecosystem development programs. Polkadot is used for building interoperable applications in various sectors, including DeFi, digital identity, supply chain management, and DAOs. 

 

6. Avalanche: capable of handling thousands of TPS, offering high throughput and low latency. Its architecture facilitates scalability through its subnets and custom virtual machines, enabling parallel processing and efficient resource utilisation. Avalanche prioritises security through its consensus mechanism, which enables quick finality and resistance to various attacks, including double-spending. It offers exceptional performance, with fast transaction confirmation times and low fees, making it suitable for high-demand applications. The network has a growing and active developer community, supported by developer resources, grants programs, and ecosystem incentives. Avalanche is used for various applications, including DeFi platforms, cross-chain bridges, gaming applications, NFTs, and enterprise solutions.

 

7. Tezos: throughput varies but aims to achieve scalability through on-chain governance and protocol upgrades. It provides security through its on-chain governance and formal verification capabilities, enabling continuous upgrades and bug fixes. Transaction costs on Tezos are relatively low, providing cost-effective solutions particularly for applications requiring secure and scalable smart contracts. The network boasts a growing developer community. Tezos is used for a wide range of applications, including DeFi, digital identity, tokenization, real estate and governance solutions. 

 

8. Algorand: throughput exceeds 1,000 TPS, offering high scalability and fast transaction confirmation times. It enables security through its pure Proof of Stake consensus mechanism. Transaction costs are generally low. The network has a growing developer community. Algorand is used for DeFi, asset tokenization, stablecoins, and government applications.

 

9. NEAR Protocol: throughput varies but aims to achieve high scalability through its sharding and parallel processing capabilities. Security is enabled through its sharded architecture and economic incentives, enabling fast finality and protection against network attacks. Transaction costs on NEAR Protocol are generally affordable. The network is known as a developer-friendly platform, which is highly appreciated by the community. NEAR Protocol is used for various decentralised applications, including gaming, NFT marketplaces, DeFi, and Web3 infrastructure.

 

10. Stellar Soroban: throughput is capable of handling thousands of TPS, offering high scalability and fast settlement times. Security is powered by the Federated Byzantine Agreement consensus mechanism, ensuring consistency and fault tolerance. Stellar Soroban is a new entrant in the smart contract space, aiming to provide a scalable and efficient platform for decentralised applications and financial services. Transaction costs are generally low. The developer community is in its building phase, since the solution itself is brand new. However, the Stellar network itself was launched as early as 2014, so Soroban will definitely benefit from the community that matured around Stellar for a decade. Stellar Soroban aims to be used for cross-border payments, asset tokenization, remittances, and decentralised exchanges. It also plans to implement all the relevant major features of other smart contract networks to expand into lending, borrowing, trading and other applications.

You can see the comparison table of some smart contract networks here.

Conclusion

 

Based on the data provided above, you can narrow your search for the smart contract platform that suits your needs best. There are quite a lot of parameters to consider. For instance, if you need a cost-effective and innovative solution, you might choose Stellar Soroban as one of the cheap, fast and promising platforms. If you are looking for a solution based on a widely accepted platform you might opt for Ethereum or revert to Binance Smart Chain if you need just a tad more speed. If performance and speed are paramount, your choice might be Solana, which seems to be gaining popularity. Weighting numerous pros and cons, you will be able to find compromise between performance, security and costs, crucial for any business application. Also it might be a good idea to speak to the members of the developers’ community: small but important details can stay unnoticed at the theoretical research phase but are well known to those who delve deep into practical solutions. Good luck and welcome to the smart contract world!

 

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Comments: (1)

A Finextra member
A Finextra member 22 March, 2024, 08:08Be the first to give this comment the thumbs up 0 likes

Thank you for the guide!

Dmitri Gmyza

Dmitri Gmyza

Co-Founder

Ultra Stellar

Member since

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Location

London

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