Smart Contract: definition and operation

Smart Contract: definition and operation

A smart contract is a dematerialized contract concept that has been developing rapidly in recent years based on blockchain technology. Inexpensive and without intermediary, the smart contract allows stakeholders to automatically execute the terms of their agreement in a secure environment. While it has many benefits, it is important to understand how this digital contract works.

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Theorized in 1994 by scientist and cryptographer Nick Szabo, the smart contract has developed in recent years with the arrival of cryptocurrencies. Today, it is the Ethereum blockchain that uses smart contracts the most. The smart contract is the computer equivalent of the traditional contract, except that it has no legal framework. Indeed, a smart contract does not respond to the rules of law, but to the computer code, France having not yet legislated on their use.

The smart contract registers the conditions defined in the blockchain. These cannot then be changed. The terms and conditions of performance of the contract are thus secure and tamper-proof, which reduces the risk of legal disputes. Automation also reduces the risk of interpreting conditions. The computer code decides whether the execution of these conditions should be partial or total. The smart contract therefore ensures the proper execution of the commitments made by the various parties involved. Consequently, a contract could be canceled or a payment suspended automatically if the conditions were not fully respected.

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The smart contract offers many benefits. It considerably simplifies the development and execution of the contract thanks to the automation of processes. It thus reduces costs, because there is no longer any need for an intermediary, such as a notary or a lawyer, to draw up the terms of the contract or ensure their execution. With the smart contract, exchanges are fast and secure thanks to the immutability of the blockchain. It guarantees transparency. Data is public, immutable and tamper-proof.

On the other hand, the smart contract also has a major drawback: a possible flaw in the programming. The more complex the smart contract, the higher the risk of a breach. Blockchain data is public and can therefore be viewed by anyone. Smart contracts involve significant economic stakes, which interests people looking for flaws in the system in order to obtain financial benefits.

How does a smart contract work?

First, the parties involved must agree on the terms and conditions of performance of the contract. These terms and conditions are immutable, so care should be taken to craft them and ensure that they are suitable for all stakeholders.

Once the parties have consented to the terms and conditions of the contract, the smart contract data is entered into the blockchain either through a developer or using a standardized smart contract template. Blockchain refers to a distributed database that allows information to be stored and exchanged securely. The sharing of information is carried out on a set of users, which is called a chain of blocks. Ethereum is the most used blockchain for smart contracts, but there are other blockchains that use them like Algorand, Tezos, Solana or Polkadot. Encoding the smart contract data in the blockchain is a delicate step, because you have to be careful about possible bugs. If there is a flaw in the contract code, hackers can use it to steal contract data or transaction money.

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If the conditions are met by the parties, the contract is then executed normally according to the agreed terms. But if a party does not comply with the conditions, then the contract is void. The transaction is visible to everyone on the blockchain, however the parties remain anonymous. However, it is possible to integrate a smart contract with a private blockchain to limit accessibility. Indeed, the code and the execution are accessible to all except in the case of a private blockchain, because the project is not decentralized. The administrator can then change the contract. This may be in order to improve its efficiency, to deploy new features or to solve a security vulnerability.

The absence of an intermediary during the transaction is only valid if the property sold is dematerialized, since it must pass through the blockchain to pass to its new buyer. If the property concerned is material, then it will be necessary to call on a trusted third party, an oracle, who will be registered in the smart contract and who will ensure that the property has been transferred to the new owner.

Examples of smart contracts

Augur: smart contract and predictive markets

Augur is a marketplace, decentralized platform using Ethereum technology. It offers its users to bet on events that could happen, a sort of prediction market. This platform is governed by smart contracts linking the different asset holders within the same ecosystem.

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Augur and smart contracts

Etheremon, the smart contract in the field of online games

In the Etheremon game, the player can track, capture and evolve characters in a world of ether monsters. This decentralized application allows no possible cheating and no character theft. This game is secured by the use of smart contracts linking each player and, for the sake of transparency, the data is visible to all.

ethermon and smart contracts

Societe Generale – Forge on the blockchain with “security tokens”

In 2019, Société Générale SFH (a subsidiary of Société Générale) issued the first covered bond in the form of “security tokens”. For this, it used a public blockchain with the aim of developing new activities in the capital market. Société Générale (with in-house startup Société Générale Forge) issued €100 million of covered bonds in the form of “security tokens” using the Ethereum blockchain, thus facilitating the transfer and settlement of securities with deadlines of marketing shortcuts.

general society and smart contracts

Vacheron Constantin on the blockchain with the certification of its watches

Vacheron Constantin is the first luxury watchmaker to offer certification of authenticity for its watches using blockchain technology. Thanks to this tamper-proof certificate, the company fights against counterfeits, reduces its paper consumption and offers innovative customer service. With access to “The Hour Club” platform, Vacheron Constantin customers can save and retrieve the digital authentication of their watch at any time and until the end of its life cycle, as well as consult a guide of use or all the technical data of the product.

Vacheron Constantin and smart contracts

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