Ethereum is a very popular decentralized platform that develops smart contracts. These contracts run on Ethereum Virtual Machine, a software platform that developers can use in order to create decentralized applications (dapps) on Ethereum.
“Decentralized platform” means that anyone can set up and run an Ethereum node. Any user wishing to run a smart contract must pay the operators of these nodes in Ether, the cryptocurrency token linked to Ethereum. Thus, people running Ether nodes provide computing power and are paid in Ether.
In other words, while Bitcoin is mostly used as a payment network, Ethereum is a distributed blockchain network that can be used for many other things. In this article, we will discuss how Ethereum smart contracts work and how you can use them to your advantage.
What is Ethereum?
When we think about cryptocurrency, Bitcoin and Ethereum are the most popular names that come to mind. Ether (ETH) is Ethereum’s native currency and the second largest cryptocurrency after Bitcoin.
However, Ethereum is not just a cryptocurrency and, in fact, is not in direct competition with Bitcoin. Ethereum was created in 2015 by Vitalik Buterin, who successfully pointed out the limitations of Bitcoin’s functionality.
Computers around the world host the Ethereum blockchain, and every computer has a copy of the blockchain. There must be a broad agreement before any changes can be implemented in the network, just like in the case of Bitcoin blockchain. However, the Ethereum network is more sophisticated than Bitcoin, as it allows developers to build decentralized applications (dapps) through smart contract groups, which will be stored on the Ethereum blockchain.
ETH tokens feed the Ethereum blockchain network, allowing users to make transactions, earn interest on their holdings, use and store non-fungible tokens, trade cryptocurrencies, play games and use social networks.
What are Ethereum smart contracts?
The Ethereum network hosts smart contracts, which are collections of code that execute a set of instructions and run on the Ethereum blockchain. They are called contracts because the code running on Ethereum can control valuable digital assets, such as Ether tokens.
The concept of smart contracts is not new. It was first proposed in the early 1990’s by Nick Szabo, who invented this term. However, smart contracts have grown in popularity in recent years and are now transforming the way companies work to increase efficiency.
Smart contracts work as “if-then” digital statements between two or more parties. A computer network performs actions, by releasing funds to the appropriate parties when certain conditions are met and verified.
The Ethereum blockchain is updated when the transaction is completed, which means that the transaction cannot be modified, and only the parties who have been granted permission can see the results.
How do Ethereum smart contracts work?
On Ethereum, smart contracts are written in its programming language called Solidity, which is Turing-complete. This means that the rules and limitations of smart contracts are included in the network code, and no hacker can manipulate the rules. Ideally, these limitations would mitigate scams and hidden contract changes. Smart contracts can only take effect if all participants agree.
An Ethereum smart contract is basically an application run by Ethereum Virtual Machine. It is based on the decentralization principle and the totality of the Ethereum nodes. Each node that supplies power to the network receives Ether tokens as payment for the delivered energy.
“Smart” also means that the user who writes a contract can enjoy its benefits when all the conditions are met. In order to execute a smart contract, the user must send enough Ether tokens as the equivalent value of the transaction. The amount of tokens is dependent on the need for resources requested by the computer during the operation.
Payment represents the fulfillment of obligation to the Ethereum nodes that provide the necessary force for the operation of the transaction initiated by the user. Ethereum offers the chance to use smart contracts by entering the terms of the contract in a series of code terms. Once registered in the blockchain, the contract is authorized by Ethereum and it begins to be executed, without the possibility to be modified later, which prevents hacking.
First of all, a smart contract requires an agreement between two or more parties. Once this is established, the users can agree on the conditions under which the contract will be considered completed. The decision would then be written in the smart contract, which is encrypted and stored in the blockchain. Once the contract is completed, the transaction is recorded on the Ethereum blockchain just like any other. Then all nodes will update the blockchain with this new transaction.
What is the Ethereum Virtual Machine?
Ethereum Virtual Machine (EVM) is a single entity maintained by thousands of connected computers running on Ethereum blockchain. The main purpose of the EVM is to determine what the overall state of Ethereum will be for each block in the blockchain.
The Ethereum protocol exists exclusively for the purpose of maintaining the continuous, uninterrupted and immutable operation of the Ethereum Virtual Machine. It is the environment that supports all Ethereum accounts and smart contracts.
The advantages of using Ethereum Virtual Machine are:
- It allows every user to create their own dapps (decentralized applications). There are many use cases for this kind of software, and the technology is never restricted to a certain group of users.
- There are many potential benefits of smart contracts. A great example would be non-fungible tokens (NFTs). By creating NFTs, anyone can create digital art and sell it on a decentralized marketplace. This action has the potential to free access to the art market in a virtual way, something that was not possible before.
The disadvantages of using Ethereum Virtual Machine are:
- The EVM network is not entirely decentralized. Most Ethereum nodes are hosted on centralized cloud servers. If the owners of such services decide they don’t want to host Ethereum anymore, the nodes could easily be shut down, damaging or destroying the network. This has happened before on certain social media applications.
- The EVM requires technical knowledge. Users who don’t know how to code cannot use the EVM properly. More user-friendly interfaces are still in the process of being developed. Once again, NFTs are a good example: there are programs that have graphical user interfaces (GUIs) that allow almost anyone to create NFTs and then use various marketplaces in order to sell them.
- High gas fees during times of network congestion. This can become a big disadvantage for most Ethereum users. While those sending large transactions might not be affected as much, all the other users trying to send smaller transactions might be unable to use the network for a specific period of time. This creates problems for decentralized applications. When many users are interacting with smart contracts and they are creating transactions, things can slow down or even stop working when gas fees get too high.
Every action that you take on the Ethereum platform represents an ETH transaction. These transactions require fees. On Ethereum, fees are referred to as Gas, as in the gas that powers decentralized applications. When there is a lot of network activity and many transactions are happening, Gas fees often rise. Sometimes, it can cost as much as 10 dollars or 20 dollars worth of ETH to make a simple transaction.
The main challenges of Ethereum smart contracts
Although smart contracts are a great concept, they are definitely not perfect. First of all, smart contracts and blockchain networks are manually programmed. This means that human error is always possible and it can lead to various problems. Such an example is the infamous attack on Ethereum’s Decentralized Autonomous Organization (DAO) in 2016. Hackers exploited a vulnerability in the DAO smart fundraising contract in order to steal funds worth of over 50 million dollars.
While the idea of a secure money transfer process looks great in theory, there are a number of governmental implications that need to be considered. Also, smart contracts cannot extract information outside the network in which it exists, at least not in its current state. In other words, you cannot upload data from an existing website into an Ethereum smart contract.
Final thoughts on Ethereum smart contracts
The Ethereum smart contract is a computer code that runs using blockchain technology. It allows the exchange of money, content, ownership, shares and other valuables. The smart contract is executed automatically when the initial conditions are met without intermediaries.
Smart contracts have developed over time. They initially started as simple “if-then” statements that a programmer could create and implement. Since then, developers have made it possible for users to create smart contracts without programming knowledge. However, programmers have the ability to increase security by creating alternatives such as secret contracts and designing ways to automatically store contract history in a plain readable format.
Nowadays, smart contracts are used by many banks and insurance companies in their daily operations, so we might as well become familiar with this new technology that could save us a lot of time, money and energy.