What are Smart Contracts – A Complete Guide For Beginners

In the last few years, the blockchain technology space has seen quite some evolutions through some applications like a decentralized exchange, smart contracts, smart properties, and many others. In this light, this guide will be uncovering one of the revolutionary discoveries in the financial and blockchain space, Smart Contracts.

Introduction to Smart Contracts

Smart contracts are a set of instructions structured digitally and are embedded with a self-executable IFTTT – if this, then that – code. They are programs that are stored on a blockchain and are executed when some sets of predetermined conditions are satisfied. These programs allow for decentralized automation that facilitates, verifies, and enforce the conditions of a certain agreement.

Smart contracts allow you to exchange anything whatsoever as long as they have value like shares, money, properties, and others alike in a manner that is transparent eradicating the need for a third party and keeping a conflict-free system.

For instance, in the real world, some transactions will need you to get a document registered in court as proof which will be required that you go through a notary or lawyer. And these services will require both money and time. However, with smart contracts, such legal needs are catered for without the involvement of a third party. Furthermore, the work of smart contracts is not limited to defining rules guiding some agreements, but it spans through to the automatic execution of these rules.

So, to define in layman’s words, smart contracts are the line of codes or programs that runs automatically according to the preset instructions of their creator. They are really useful in business collaborations where two parties will need to agree on some predetermined terms based on the consent of the involved parties. With this innovation, there is no need for a third party to be aware of what you are about to get into, thereby increasing privacy, reducing the risk of fraud, and ultimately reducing costs.

To summarize in line with the operation of the crypto space and blockchain technology, the mechanism on which smart contracts are running involves the transfer of digital assets between multiple parties where the concerned parties get to govern their own assets automatically. There are predetermined rules of the contracts that allow them to deposit and redistribute the assets among the participants.

The properties of smart contracts include self-execution, self-verification and tamper-proof.

How smart contracts work

Smart contracts run on simple iterations like if/when…then which are written as lines of code on the blockchain. The actions are then executed by a network of computers anytime the predetermined conditions are met and confirmed. Examples of actions run on with smart contracts are registering a vehicle, issuing a ticket, releasing funds to the appropriate persons, and many more. After the transaction, the blockchain will then be updated which means that the transaction is sealed and cannot be changed, and only the permitted parties can see the results of the deal.

When it comes to smart contracts, there is the liberty to add as many stipulations as needed to be met and satisfied by the participants for a transaction or task to be completed satisfactorily. On the part of the participants, they must first determine how the transactions including their data are represented on the blockchain. Then they are required to agree on the “if/when…then” conditions that the transactions run on while they explore all available exceptions and define the framework for dispute resolution if there are any.

After all these things are in place, a developer programs the smart contract, though there are some templates, web interfaces, and other required tools available for those using the blockchain for business. These tools help them simplify the structure of smart contracts.

Why Smart Contracts can be Trusted?

For all relationships, especially those with no face attached to them, trust must be established for it to run smoothly. Starting from the government we are voting for, to the banks we employ to secure our money, or the insurance company promising to be there if anything should go wrong.

One of the problems that exist in our systems is the fact that the helm of affairs (organizational and political) is in the hand of humans who is as vulnerable as any other. This automatically opens the door to manipulation, foul play, and corruption in these settings at any point.

Compared with smart contract, the mess in the traditional systems are eradicated as the evolution promises transparency and a manipulation-proof operation. You can be sure that once you initiated a smart contract, it will run exactly the way it was programmed and there is no party strong enough to influence or interfere with the result till it is completed and even after. This means that even if we don’t trust our fellow citizens, we can trust a smart contract.

The Use Cases of Smart Contracts

Ranging from online data encryption to financial transaction execution, there are various use cases of the smart contract technology, and in this section, this guide will uncover them.

1. Smart Contract on Ethereum Network

Currently, in the crypto space, the Ethereum network is the biggest platform for the creation and deployment of smart contracts. Every smart contract on the Ethereum network is programmed as assigned to a specific address over the network. This is what makes the code of that contract public since it is stored on the blockchain.

A blockchain is a digital ledger used for making transactions public in blocks like Ethereum and some other crypto set-ups. With this technology, there is no need for a middleman as these transactions are transparent, making them more lucrative for businesses and organizations.

2. Crowdfunding

The use of smart contracts in crowdfunding is another prominent use case. This is a very suitable option for anyone or business looking to raise funds or offer a coin to their customers. In the traditional stock market system, there is such thing as an initial public offering, but in the crypto space, it is called an initial coin offering (ICO), which afford the crypto startup to raise funds for their operations.

Aside from these two listed above, there are other prominent use cases of smart contracts. An example is IoT – Internet of Things, Supply chain, insurance companies, copyrighted content, and decentralized voting.

Furthermore, there are some smart contracts written in Solidity programming language and are wrapped in a website presentation mode. These smart contracts are often called dApps (decentralized apps) and are found in voting, gambling, and e-sports field.

What is a Smart Contract Audit?

As a means to provide extra security for funds invested through smart contracts, there is a need for a routine audit called a smart contract audit. This audit provides a well-detailed analysis of the smart contracts of a project. The audit is in place because there is no way to retrieve any stolen funds in the project as all transactions are final on the blockchain.

In a smart contract audit, examination and comments are passed on the codes of the project’s smart contract code. Most of these smart contracts are written with the Solidity programming language and are pushed on GitHub.

Auditors examine the code of the smart contracts and simply prepare a report which is submitted for the project team to work on. In the report, all the outstanding errors are detailed including the work already done to address security and performance issues.

The importance of a smart contract audit is the same as the audits in the cybersecurity space. This is to say that smart contract audits are very important for the Decentralized Finance ecosystem. These audits are important, especially for DeFi projects that are handling huge among of users or transactions worth millions of dollars.

In a smart contract audit, there are essentially four steps to follow.

1. The audit team gets access to the smart contracts for initial analysis.
2. The audit team compiles their reports for the project team for follow-up.
3. Based on the issues found and the recommendations made by the audit team, the project team moves to execution.
4. The audit team then releases the final report of the audit which confirms the new changes and other outstanding errors.

Smart contracts audit, however, is quite essential for many crypto users when they are considering investing in new projects in the DeFi space. And over time, it has become the standard for projects that want to be taken seriously in the space. And also, some specific audit providers are considered leaders in the industry because their audits are trusted over the years.

In this section of the guide, we will consider the methods, tools, and results of smart contract audits and how they can help you make better decisions.

The Essence of Smart Contract Audits

Since the total value locked (TVL) and the amount of value moved through the DeFi space is increasing, the space has become a prime target for malicious attacks. To put it in better perspective, a single error in the smart contract codes can make the entire code vulnerable to attack thereby, leading to millions of dollars at the risk of being stolen. For example, the DAO attack on the ETH blockchain has led to the loss of about 60 million dollars in ETH and eventually led to a hard fork of the network.

The reason for this extra cautiousness is that transactions on the blockchain are irreversible, even though transparent. This means that any stolen funds cannot be recovered, hence the reason every smart contract code must be secured.

Since the blockchain technology is not designed for funds retrieval, preventing any form of vulnerability in anything built with the technology is highly essential, hence the need for the smart contract audit.

How Smart Contracts Audit work

Though each audit provider might have a different approach to the task, there are standard processes for everyone to follow. In this section, we will consider the typical approach to a smart contract audit.

1. Establish the scope of the Audit: To start with, the specifications of the project and the smart contract including the overall architecture of the project must have been defined. This is to help the audit team understand the goals of the project which will guide their interaction with the code and help them write a tailored report for the audit.
2. The Audit team provides the project team with the quote based on the amount of work needed to be done.
3. Run Tests: Here is where audit teams bring in their ingenuity and things begin to look different. The nature of tests, methods, and analysis tools of the auditing team is different. However, in any case, both automated and manual tests are carried out.
4. Compilation of the first draft of the report by the auditing team for the project team to uncover all the errors in the smart contract which must be fixed in a follow-up.
5. Publishing the Final report after the project team must have attended to the issues raised in the previous draft.

Methods of Smart Contract Audit

·         Gas Efficiency

Beyond the security of the blockchain, smart contract audits pay attention to optimization and efficiency. Some smart contracts might have some series of underlying complications with transaction completion which might impede the intended function. Oftentimes, gas fees on networks like Ethereum can be unbearable and relatively costly, improving the efficiency of smart contracts can help users save quite a lot on the cost of transactions.

Needless to say, an optimized performance is an indicator of the skillfulness of the project developer which can be a point of attraction for users in the space. However, it is important to avoid inefficient steps that can lead to failure. Also, most smart contracts fail when the gas fee is high especially when there is a gas limit activated.

·         Contract Vulnerabilities

The bulk of work on smart contracts audit revolves around looking for security vulnerabilities in the contracts. It can be easy to sight some, but others can be exploited with more advanced and technical strategies. For example, attackers can use market manipulation with weak smart contracts to execute flash loan attacks. So, to uncover most of these issues, auditors need to use the break testing process where they simulate an attack on the smart contract in a bid to locate the vulnerable spot. Common vulnerabilities in smart contracts include:

1. Front running opportunities: a poorly structured code can give forewarning to users for a potential buy or sell. This can then allow users to use that signal to their own advantage which can be very detrimental to the project.
2. Reentrancy issues: This happens when a smart contract initiates an interaction with another smart contract, but before the effects are resolved or the balance is updated, the external contract leverage delay interacting with the original contract.
3. Integer underflows and overflows: This happens when a smart contract executes an arithmetic operation but the storage capacity couldn’t contain the output (usually 18 decimal places). This can lead to wrong calculations and the incorrect amount being lodged.

·         Platform Security flaws

For a complete audit, the network hosting the smart contracts must be audited. This includes the API interacting with the dApp. Most often, the vulnerabilities of a smart contract can come from the website UI compromise or a DDoS attack, which can make users connect their wallets to malicious applications on the blockchain.

What then is an Audit Report?

At the end of every audit process, there must be a report that highlights the issues discovered during the process. As a way of encouraging transparency and increasing trust, some projects share the report with their community.

In the report, the issues are categorized based on their severity from the minor issues, to major issues and the critical ones. Also in the report, the status of the issues is listed which is updated after the project team must have worked on the issues.

Also, the report contains an executive summary, a breakdown of the coding errors found, and the time required to fix those errors. It is after then the final version of the report is released.

Places to get Smart Contract Audit Services and Cost

Of course, you can find a number of smart contract audit services in the crypto space, but there are two that particularly stand out. One is CertiK while the other is ConsenSys Diligence.

CertiK has grown to be a household name in the DeFi space and it has audited some popular projects in the crypto space including PancakeSwap – the biggest BSC Automated Market Maker. Altogether, the audit service specializes in BSC – Binance Smart Chain and Polygon projects. ConsenSys Diligence, on the other hand, focuses on projects on the Ethereum network. However, it will be less surprising after knowing that it is run by a co-founder of Ethereum, Joseph Lubin.

In terms of financial cost, you cannot really ascertain the cost of smart contracts audit as there are a number of them to be audited. However, a typical audit can cost thousands of dollars up to $10,000. Also, another thing that influences the cost of the audit is the integrity of the company running the auditing.

Conclusion

Over the years in the DeFi space, smart contract audits have become the standard. However, beyond the project interpretation of the reports, you must be able to read them yourself. Even if you don’t have the technical know-how to read the report, you can watch out for other investors’ comments to measure the severity of some issues raised.

However, the contents of an audit report are normally easy to understand, but ultimately, you are encouraged to consider everything involved with a project before taking any investment decision.