To understand DeFi, you need to know how Decentralized Exchanges work. To know how Decentralized Exchanges work, you need to understand smart contracts.
Smart contracts are potentially one of the most useful tools associated with blockchain. They can transfer everything from bitcoin and fiat currency to goods transported worldwide.
What are Smart Contracts, and How do They Work?
These are computer programs stored on a blockchain that executes or records events automatically based on conditions agreed upon. Once completed, the transactions are trackable and irreversible.
Smart contracts permit trusted transactions and agreements to be carried out among disparate, anonymous parties without a central authority, legal system, or external enforcement mechanism.
While blockchain technology has come to be thought of primarily as the foundation for Bitcoin, it has evolved far beyond underpinning a virtual currency.
Using the Ethereum Blockchain as an example, users interact with Dex built there and in a situation where a user wants to swap $ETH for $OP tokens. They interact with the smart contract built in that Defi protocol, e.g. Uniswap. This transaction is recorded in the blockchain, which is stored forever and can always be referenced in the future. Like the traditional system, we use receipts as proof of transaction, but this can either get manipulated or misplaced.
This Smart Contract idea was established by Nick Szabo, a computer Scientist, in 1994, who envisioned a secure and automatic method of carrying out transactions using cryptography.
Pros and Cons of the Smart Contract Technology
Pros
Efficiency- They speed up contract execution.
Accuracy- There can be no human error introduced.
Immutability- The programming cannot be altered.
Cons
Permanent- They cannot be changed if there are mistakes.
Human factor- They rely on the programmer to ensure the code addresses the terms of the contract.
Loopholes- There may be loopholes in the coding, allowing contracts to be executed in bad faith.
Smart Contracts Use Cases
Because smart contracts execute agreements, they can be used for many different purposes. One of the simplest uses is ensuring transactions between two parties occur, such as purchasing and delivering goods. For example, a manufacturer needing raw materials can set up payments using smart contracts, and the supplier can set up shipments. Then, depending on the agreement between the two businesses, the funds could be transferred automatically to the supplier upon shipment or delivery.
Real estate transactions, stock and commodity trading, lending, corporate governance, supply chain, dispute resolution, and healthcare are only a few examples where smart contracts can be used.
Final Thoughts
Smart contracts are code written into a blockchain that executes the terms of an agreement or contract from outside the chain. It automates the actions that the parties would otherwise complete in the agreement, which removes the need for both parties to trust each other.
Comments