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VP Trading and Research Sean Rooney breaks down the concept of Smart Contracts.
The concept of smart contracts was introduced in the 1990s. We've seen a progression of potential use cases as crypto continues to grow and innovate as an asset class.
With regards to crypto, we think of smart contracts as an application or program that runs on a blockchain. The Bitcoin protocol has been supporting smart contracts for many years, however, they were made more popular by Ethereum and now other Layer One Platform protocols such as Polkadot or Avalanche.
How smart are these contracts?
Smart Contracts facilitate three functions: To store rules of a contract, verify those rules, and self execute the agreement based on the rules.
The basic idea behind this technology is that two or more entities can make an agreement on the blockchain without the need for an intermediary, or the need to trust or know one another.
Perhaps, to some, the grand vision of smart contracts and their use in a decentralized finance (DeFi) would be to facilitate any number of financial services from borrowing and lending, real estate, or insurance.
One common example of using smart contracts for insurance relates to crop insurance. A farmer could purchase crop insurance to mitigate the risk of there not being enough rain. Based on the amount of rainfall that season, the contract would automatically pay out to the farmer based on the pre-arranged rules of the contract between the insurer and the insured.
Smart contracts become viable only when their conditions can be completely transcribed into the code.
Unfortunately, this is somewhat of a rare scenario as a significant portion of contracts are in fact filled with nuances. Back to the crop insurance example, who decides how much rainfall has actually occurred in a very particular geographical location that season? Already, we’re bringing in other parties. For that particular use case, smart contracts could be somewhat tricky.
A legitimately intelligent contract might take into account mitigating circumstances, think about the spirit of the contract, and then distribute funds in an even and fair manner, even in extreme gray areas or confusing circumstances.
What are smart contracts used for today?
Liquidity pools, DeFi, creating and utilizing new tokens on top of layer one protocols, and NFTs. All of these are made possible and powered by the use of smart contracts.
It will be interesting to see if smart contracts continue to develop and mature in order to fill some of the future use cases many people are looking for, such as protecting copyrights, digital identity storage, digital data recording, and much more.
Perhaps similar to NFTs, the fairly new technology exists in its current state, but perhaps we’re under estimating the deeper implications of smart contracts that are still to come.
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