Web3 is a decentralized form of the internet that is trustless and permissionless, effectively eliminating the need for intermediaries. But when it comes to sensitive sectors of Web3, such as finance, it would be silly for us to believe that everyone would be of good behavior. Decentralized Finance (DeFi) might be free from traditional forms of regulation, but DeFi still has its own method of regulating itself. From my view, money is money, and nobody likes to lose it.
Bitcoin recognized the need for self-regulatory measures to validate all transactions. Mining machines to track transactions were developed on the Bitcoin blockchain, but these protocols are not scalable. They consume too much electricity and are quite expensive to run.
Ethereum solved this problem with the introduction of smart contracts in its blockchain. Smart contracts replace intermediaries, which are an integral part of centralized finance.
What are smart contracts?
Contracts are agreements that bind two parties together, clearly stating their obligations. Simply put, a contract tells you what to do and what the other party bound by it is expected to do in return.
Smart contracts are not too different from regular contracts. They are digital instructions written on a blockchain to control chain activity. Unlike regular contracts, where you have to trust that the other parties involved will comply, smart contracts are automated to execute certain transactions once the conditions are met.
With smart contracts, there is no need for a third party enforcing contract compliance. The codes are written in such a way that once a user meets the conditions, the transaction is recorded on the blockchain and executed automatically. Smart contracts can also be employed to automate blockchain workflow.
A brief history of smart contracts
First proposed in the early 1990s by a computer scientist named Nick Szabo when he developed a digital currency called Bit Gold. Bit Gold never really took off, but in 2014, Ethereum incorporated smart contracts in its blockchain when it launched. The Ethereum blockchain is still the most popular application of Nick Szabo's smart contract principles.
Over time, developers have made it possible for people to be able to write these contracts without any special knowledge of coding. They are developing ways for blockchains to store contract history in human language.
How do smart contracts work?
Smart contracts are designed to obey IF/THEN commands. The "IF" being the conditions that trigger the execution of a set of already determined actions. This structure doesn't require third parties monitoring to see if the conditions have been met before they initiate the other part of agreements. Smart contracts are automatic, so irrespective of who meets the stipulated conditions, they are obliged to keep up their part of the deal.
Ethereum on its website gives a good illustration of how smart contracts work. They liken them to vending machines. On a vending machine, you select the product you want, insert the amount as indicated by the machine, and automatically your product is dispensed. The machine will only dispense a product if the right amount is inserted into it. Vending machines, like smart contracts, do not require approvals from a third party.
Not only can anyone take part in the contract by meeting the requirements, anybody can also write and deploy smart contracts on the blockchain. You only need to be able to write codes in a programming language accepted by the blockchain. Ethereum smart contract programming languages include Solidity, Vyper, Yul, or an intermediate language.
To deploy smart contracts onto the blockchain, you also need to pay a gas fee. Gas fees for deploying smart contracts are more expensive than other blockchain transactions. Ethereum isn't the only blockchain that uses smart contracts. Blockchains like Arbitrum, Aurora, BNB Chain, C-Chain, Moonriver, Optimism, Polkadot, and a host of others use smart contracts.
Why smart contracts?
Since its introduction on the Ethereum blockchain in 2014, smart contracts have aided the widespread development of decentralized applications. The decentralization of the internet is largely possible due to smart contracts. The automation that smart contracts bring makes it easier to trust a trustless process.
Once the conditions of the contract are met, the process is self-executed. This way, even without third-party supervision, you can be sure that contract agreements will be kept. The outcomes of smart contracts are predictable as you already know what will happen if you comply with the requirements.
Smart contracts are written on the blockchain, meaning they are open for all to see and can't be altered. Their stipulated conditions cannot be changed halfway into the process. You can be rest assured that you won't be cheated. All transactions are documented in the blockchain and distributed through the network. These records are encrypted and can't be deleted.