Smart Contracts And Their Mission. Part 2

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The history of smart contracts is longer than most of us are inclined to assume. How it all started, who was behind the concept, and what was required to make smart contracts possible in practice — all of that you can learn in the first part of this exposition. Here we are going to explore practical implementations of the technology and then top off with what smart contracts are trying to achieve, what their mission is.

Smart Contracts And Cryptocurrencies

As smart contracts were first introduced in the cryptocurrency space, it is little wonder they got universal adoption for use with crypto. Bitcoin and other cryptocurrencies are mostly utilized as vehicles for trading and often serve as investment assets, so the first use cases of smart contracts were associated with this field. More specifically, smart contracts lie at the core of the vast majority of decentralized exchanges like IDEX and decentralized stablecoins such as MakerDAO’s Dai that work as proxies to fiat currencies on these exchanges.

Smart contracts are the sum and substance of the newest approach to decentralized trading based on liquidity pools and automated market maker protocols. Conventional exchanges, whether decentralized or otherwise, use order books to discover the market price through the equilibrium of offsetting orders. Here you trade against other traders. With liquidity pools, however, you trade directly against a smart contract where the price is determined by the balance of pooled reserves aka liquidity held by the contract.

The exchanges leveraging this technology such as Uniswap, Curve, Balancer, Kyber, 0x, dYdX have easily overtaken all other decentralized exchanges thanks to the simplicity of use and trustless nature that smart contracts and decentralized applications built on top of them provide. And you can not only trade there but also provide liquidity through the same smart contract and earn by accumulating fees. With centralized exchanges, you forever remain at the mercy of the exchange, so the immense popularity of these services is well deserved.

The introduction and development of the smart contract technology led to the emergence of an entire new field in the crypto space that came to be known as decentralized finance, or DeFi for short. DeFi aims at removing intermediaries from the financial services with the help of smart contracts. Decentralized lending & borrowing that has got a lot of traction recently is the service which fully embraces this ethos. Instead of banks, lenders and borrowers use decentralized lending platforms that employ smart contracts under the hood.

The smart contracts that power the vehicle of decentralized lending & borrowing enable a trustless environment from which both lenders and borrowers benefit tremendously. The absence of intermediaries, no need for credit bureaus, automatic enforcement of lending terms greatly reduce overhead costs and simplify the entire process — all thanks to the magic of the smart contract tech. To be sure, the space is crowded with big and small players such as Aave, MakerDAO, Compound, etc that are eager to leverage this technology.

In his seminal paper on smart contracts Nick Szabo, a computer scientist who first came up with the concept of smart contracts, suggests their use for building synthetic assets. These are formed by combining different types of assets, for example, bonds and derivatives in one way or another. And what do you think? This is exactly what Synthetix does now by creating on-chain synthetic assets, the so-called Synths, such as synthetic currencies and commodities, along with more complex assets. They didn’t even bother to change the name!

Smart Contracts Beyond Cryptocurrencies

If you want to learn more about DeFi in general and what projects are involved in it harnessing the smart contract tech, you may want to read our two-part review of DeFi here. But while DeFi is probably the best use case as well as most notable example of smart contract real-life application, this tech goes far beyond the cryptocurrency space. As there are many areas where the distributed ledger technology can be adopted in a productive way, smart contracts are one of the tools that help make these fields more efficient and effective.

Ironically, one such area is the banking sector, whose faults and failings were the primary reason and motivation behind the creation of Bitcoin, according to Satoshi Nakamoto. In a strange twist of fate, smart contract-enabled blockchains can be quite useful in this field as well. For example, trade finance is a huge part of global commerce where banks issue all kinds of bank guarantees and letters of credit. Smart contracts help in this area by streamlining the entire process and dramatically reducing the trade document turnaround.

Decentralized eCommerce marketplaces are another domain where smart contracts have already gotten wide recognition. For example, one of these marketplaces, Particl.io, implements a variety of decentralized trustless escrow. It is based on a special type of smart contract which has its roots in the game theory and famous Nash Equilibrium. The funds of the parties remain locked in an escrow contract until everyone is happy with the trade, which removes the need for a trusted escrow agent and helps avoid scams and frauds.

Smart contracts also enable the creation of tokens. A token is a smart contract that adheres to a set of rules or specifications. Just like regular cryptocurrencies, tokens must be fungible. Fungibility means that all tokens of the same type are mutually interchangeable. However, not all tokens are required to follow this rule. There is also a class of tokens that are required to follow the reverse of the rule and thus be unique. Such tokens are called non-fungible tokens, or NFTs, and they open up unique possibilities (pardon the pun).

You are most certainly familiar with CryptoKitties. A CryptoKitty is a smart contract on the Ethereum blockchain represented by a non-fungible token. This guarantees that each digital kitty is one of a kind. CryptoKitties enjoyed tremendous success and sparked off similar efforts that led to the creation of blockchain gaming. In blockchain games such as My Crypto Heroes, Decentraland, Etherbots, Gods Unchained, and their likes, NFTs are used as in-game items similar to conventional multiplayer online games, say, Warcraft.

However, NFTs have an indisputable advantage over traditional in-game items. As they are just smart contracts on a certain blockchain, for instance, Ethereum, where they are technically known as ERC-721 tokens, their owner can do anything with them. He can sell and exchange them outside the game environment, or even use them in a different game if they are supported there. This is in stark contrast with games like Warcraft, Guild Wars, or Fortnite, where the game developers have full control over any in-game item available.

Austria’s national postal service came up with a very interesting idea of using NFTs as a collectible that relies on the proclivity of many people to obsess over things such as rare coins, baseball cards, and, yes, postage stamps. Now, you can buy a stamp that can be used to send mail as before and also receive an NFT on the Ethereum blockchain that holds an image of the stamp. You bet, all issues of these stamps were sold out in less than no time. We can only praise and applaud the creativity of Austrian mailmen.

Non-fungible tokens are basically digital certificates that store information about something or someone and prove your ownership of it. That’s why they are now rapidly expanding into other areas and serve as the basis of asset tokenization. Here a non-fungible token represents a designated real-world asset that can be tangible or intangible. Today, you can even tokenize your property rights and trade them like regular stocks online, as well as invest in them if you happen to be on the other side of the trade. Just in case, the idea of property tokenization via smart contracts was also first suggested by Nick Szabo.

NFTs, under whatever name, are poised to dramatically change lots of fields and areas in the coming years. But let’s not forget that they are still smart contracts, although of a special kind, with each instance designed to be unique.

Mission Of Smart Contracts

It can be said that Bitcoin made a revolution while smart contracts extended it far beyond the reaches of finance where Bitcoin truly belongs. This called for the technological innovations making up for the lack of the required functionality that the blockchain is capable of delivering but that was, and mostly still is, absent in Bitcoin. In a sense, smart contracts are trying to achieve what Bitcoin failed to.

Having evolved into a mature technology, smart contracts are actively making inroads into areas that are not even remotely related to cryptocurrencies, but where blockchain can still prove valuable and instrumental as use cases described above clearly demonstrate. In this manner, the mission of smart contracts consists in realizing the full potential offered by the blockchain technology.

In other words, it is not so much about blockchain as smart contracts leveraging it to the hilt.

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Smart Contracts And Their Mission. Part 2 was originally published in The Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.

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