Smart contracts change the way we conduct deals online. They are self-executing code on blockchain networks that enforce terms automatically without middlemen. Though the technology has the promise of efficiency and transparency, it also poses certain challenges which businesses need to know before roll-out. The growing adoption across industries indicates both enormous potential and heinous pitfall risk.
How Smart Contracts Work in Practice
Smart contracts operate on code that follows programmed conditions. When you trigger certain events, the contract takes its programmed action automatically. All smart contract development company build these programs to replace traditional contract enforcement with auto blockchain solutions. The process operates in four fundamental stages:
- Development and testing of code on local networks;
- Security auditing for detection of possible vulnerabilities;
- Deployment to the target blockchain network;
- Automatic triggering upon fulfillment of conditions.
Consider a simple flight delay insurance policy. The intelligent contract taps into flight APIs and pays claims directly once delay duration reaches two hours. Zero man in the loop – the system checks the flight status, validates delay duration, and pays out the passenger’s wallet. AXA insurance launched a product such as this called Fizzy that paid out thousands of claims automatically.
Real-World Applications That Actually Work
Multiple industries now utilize smart contracts for real-world applications. Supply chain tracking is one such example where companies trace product movement from the producer to the consumer.
The technology destroys paperwork, reduces fraud, and provides real-time tracking. Some key areas of implementation are:
- NFT marketplaces for trading in digital assets and paying royalties;
- Gaming platforms for in-game asset trading and ownership;
- Automated subscription billing and access control services;
- Secure and tamper-free election systems;
- Intellectual property licensing for regular interval royalty payments;
- Energy trading to facilitate sale of renewable energy peer-to-peer.
Walmart uses smart contracts to track food products throughout their supply chain. If contamination occurs, the system will immediately identify contaminated batches and remove them from shelves. Before this, it would take weeks but now is accomplished in seconds, potentially saving lives and reducing liability. The system tracks over 25 categories of products from many suppliers.
Critical Risks That Could Cost You Everything
Smart contract bug vulnerabilities can trigger catastrophic losses. Bug fixes cannot be done on deployed code, so once bugs are present, they are there permanently. In contrast to standard software, you cannot simply patch smart contract bugs with patches. Critical security issues include:
- Reentrancy attacks that drain funds in contracts by recursively invoking a call;
- Integer overflow bugs that manipulate math outside of variable limits;
- Front-running attacks based on memory pool transaction ordering;
- Gas limit vulnerabilities that prevent contract completion.
The 2016 DAO hack demonstrated these weaknesses when hackers exploited a reentrancy bug to steal $50 million worth of Ethereum. The attack required that the whole Ethereum network be forked, dividing the blockchain in two. The Wormhole bridge lost $320 million last month from a signature validation bug that allowed attackers to mint tokens unaware.
Business and Legal Challenges You Should Consider
Smart contracts exist in a legal limbo that creates compliance challenges. Contract law has historically been dependent on human interpretation and flexibility, while smart contracts execute to code regardless of whatever the varying situations or unexpected outcomes.
Regulatory challenges are:
- Location- and industry-governed compliance requirements;
- Taxation of automatic transactions and token distributions;
- Securities law challenges in regards to token categorization;
- Anti-money laundering regulations for hidden transactions.
Gas fee volatility generates random operational costs. During congested times, fees on transactions rise from dollars to hundreds of dollars, economically not feasible for low-value contracts. Ethereum gas costs were more than $70 per transaction during the busy times in 2021, excluding most applications.
Without oracles, smart contracts have no outside data access, leading to vulnerabilities of dependency. If oracle services are hacked or provide incorrect information, the contracts may run incorrectly. Chainlink, the biggest oracle network, experienced outages that broke dependent smart contracts temporarily on a number of platforms.
The permanent and irreversible character of blockchain transactions ensures errors become permanent. Amendment and correction to classical contracts are possible, but smart contracts necessitate entire redeployment. Such rigidity could lock up money or lead to circumstances where rational contract adjustments are impossible except by commencing anew from scratch.
