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Three Types of Smart Contracts. How to Develop a Smart Contract?

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Yuri Musienko
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Smart contracts are a dream that came true since they guarantee to fulfill a contract by all parties without intermediaries or guarantors. This article will detail smart contracts, their types, and how to develop them. 

What are smart contracts?

A computer scientist, cryptographer, and lawyer, Nick Szabo (many people believe that his acts under the Satoshi Nakamoto nickname, who created Bitcoin), in 1994 understood that the decentralized register could provide self-fulfilling contracts; also known as smart contracts. ‘’I name these contracts ‘’smart’’ since they are more functional than their paper ancestors. A smart contract is a set of agreements in a digital form that includes protocols within which the parties follow the agreement’’, — says Nick Szabo when he was describing the concept of smart contracts. 

According to the dictionary, a smart contract is a self-executable computer algorithm where all conditions are coded in computer codes stored in a distributed network like a blockchain. The code includes data and instructions that execute all conditions and transactions and make them traceable and irreversible. Smart contracts do not require banks, governments, or intermediaries to guarantee contract adherence.

How do smart contracts function?

If not considering technical details, smart contracts are necessary for automatic value exchange. For example, to exchange fiat for bitcoins, video games, gold, or access to a website. In addition, their working principle is similar to a coffee vendor mechanism that exchanges a client’s money for a cup of coffee without a seller. The valuables, in this case, are coffee and money, while the condition is giving enough money equal to the coffee price or other beverages. The vendor’s mechanism accepts and links the value and then does the automatic exchange. 

Smart contracts function according to an analog principle, yet the mechanism is computer code that launches particular actions (functions, operations, transactions, algorithms) if certain conditions and instructions are met. The instructions and requirements function according to the following logic ‘’if → then’’:

  • If the smart contract receives the A object (for instance, 1 Bitcoin), then the one that gave A to the smart contract receives B (e.g., 16 ETH);
  • If the smart contract receives B, then the X function will initiate (for instance, showing an animation, music, movie, or series);
  • If the smart contract receives C, then the one that gave C to the smart contract gets access to an application. 
Developers can create and deploy these smart contracts on various blockchain platforms (for example, Ethereum, Cardano, and Hyperledger Fabric). Each platform has its features and advantages for smart contract development. However, smart contracts include two parts: a code set and data. The code does the contract function, while data are the conditions. These two smart contract components employ a particular address in a blockchain. 

It’s worth mentioning that smart contracts are regularly an account variation with the same rights as a user account. Yet, in the case of smart contracts, users do not control their accounts since the smart contract code manages the account within the contract.

It’s essential since smart contracts are accounts; we, as blockchain or DApps users, can interact with smart contracts. For example, we can send tokens to smart contracts, so it exchanges them for other tokens (likewise to trading with a person), or we can command the smart contract to follow an instruction or do a function. 

Smart contract functioning scheme. Source: Medium.

Smart contracts vs. regular contracts

Smart contract advantages

The number of advantages that regular users, businesses, and governments can get if employing solutions on blockchain and smart contract technologies is large. Here are some of them:
  • Transparency. One of the prime advantages of decentralized blockchains is 100% transparency. All transactions within the blockchain are public and easy to verify. Furthermore, no one can introduce changes to present information in the network. Hence, an ordinary user and a business owner can create or employ a smart contract not worrying that a malefactor will change it to steal money or data.
  • Economy efficiency. Smart contracts can make automatic numerous manual business processes related to processing agreements. Moreover, smart contracts do not require intermediaries (lawyers, banks, brokers). Both factors allow saving significant sums of money.
  • Autonomy and time-saving. A traditional contract takes quite a lot of time and effort to write, as well as to track and monitor its implementation. In the case of smart contracts, everything is much simpler and faster: the programmer writes the contract code once, which is then used whenever needed (for example, to create an NFT or automatically fill out a bill and make transactions on it).
  • Enhancing the trust between the parties. If performing a smart contract, there is no human factor involved. This helps build and improve trust between counteragents and develop a solid, long-term relationship. If something happens, the parties will not blame each other for the violation of the contract but will jointly look for the cause of the failure.
  • Secure storage and backup. Losing data is always a considerable risk for business and governmental structures; therefore, everyone copies and backups up essential data. However, even most secure backup systems do not provide a 100% guarantee of saving data. They can simply fail, or hackers can steal data. However, in the case of blockchain and smart contracts, everything is different since data within a blockchain is stored on countless devices (nodes); hence, until the blockchain functions, data will be present.
  • Fraud prevention. If the blockchain code is proper, then smart contracts allow no chance for unauthorized access to the system that prevents fraud. Still, there is a possibility of phishing, yet it can be fixed with time.
  • Reliability and security. Smart contracts are famous for employing data security and the highest degree of encryption available on the IT market. This fact makes agreements on blockchain and smart contracts one of the safest solutions for contracts today.

Smart contract disadvantages 

There are specific difficulties and limitations to consider before employing smart contracts.
  • Security. Smart contracts protect particular critical business process elements that involve several parties. However, the technology is relatively new; hence, hackers can find a gap to attack and steal money and data. The development team and independent audits must thoroughly test smart contracts to avoid hacking attacks.
  • Leveling. Smart contracts can significantly boost business processes that involve numerous counteragents. This is their undoubted advantage, but this feature can also increase the damage to errors when events or the system get out of control. Consulting firm Gartner predicts that this could create significant problems with the manageability and scalability of smart contracts.
  • Managing. Smart contracts are difficult to implement and manage. They can’t be changed. Still, many will consider it an advantage, yet it can cause a lot of trouble related to updating the code if you need to add a comma. 

Three smart contract variations

There are three categories of smart contracts. Let’s explain their advantages. 

Smart Legal Contract

These are smart contracts based on a properly executed legal agreement, so their counterparties are legally responsible for the execution of the terms of the contract. Furthermore, it can be either a smart contract for exchanging crypto for fiat or a smart contract for registering an apartment. 

Many smart contracts are Smart Legal Contracts. They are fundamental for cryptocurrency exchange, DeFi projects, Game-Fi projects, and various platforms on the blockchain, from NFT marketplaces to metaverses, tokenization platforms, and trading real estate. 

Decentralized Autonomous Organizations (DAO)

Decentralized autonomous organizations, or DAO, are communities managed via a set of rules accepted and codified by smart contracts. Once these rules are adopted, the job of DAO smart contracts will be to enforce them and provide mechanisms for legal protection and punish violators. In other words, DAO smart contracts are laws and digital bureaucracies.

DAO examples are the Decentraland, Uniswap, Polkadot, and MakerDAO management protocols. According to the rules of these projects, they are managed by their native token holders, who can make various proposals (e.g., determine the structure of commissions, change blockchain code, add and remove parachains) and vote on them. The DAO smart contracts here are responsible for voting and counting the votes.

Application Logic Contracts (ALC)

These smart contracts function according to an application. Their task is to provide interaction between the blockchain and programs. For example, ALC is responsible for IoT integrations with blockchain or being able to employ an NFT as a game character in the Spider Tanks game. Moreover, ALC can also process the connection between blockchain and oracles.

How to develop a smart contract?

Now, as you understand blockchain solutions' concept, target, and advantages, let’s explain how to develop smart contracts for your application or business. 

Step 1: Select a blockchain platform.

The first decision to make while developing a smart contract is defining the blockchain platform to employ. Earlier, the choice was Ethereum and several other little-known platforms. Currently, the choice is wide and unambiguous. Still, Ethereum is the leader in launching smart contracts and DApps, yet the platform is slow, expansive, and hard to scale; therefore, more and more startups choose Polygon, Polkadot, Cardano, Solana, BSC, Tezos, Hyperledger, or other blockchains. 

Here are the six most popular platforms for developing smart contracts:

 Step 2: Select development instruments. 

There are numerous instruments that a developer can use to create a smart contract. They all have categories and groups according to their target. Some technologies are necessary (for instance, you can’t make a smart contract without a programming language), while others are optional. We tried to mention all popular and widely-used instruments developers employ for smart contracts. 

Step 4: Smart contract development process.

At this step, the developers write the smart contract code. They can do it from scratch, yet it is unnecessary since you can employ a template or an open-source library. Each blockchain offers a set of development tools. For example, OpenZeppelin frequently helps to launch smart contracts on Ethereum. Hyperledger also has its toolkit

Step 5: Testing the smart contract. 

Given the number of smart contract hacks we see, testing is probably the most important stage of smart contract development. The fact is that smart contracts are open-source software, which means that any hacker can study its code and find gaps to use to hack a smart contract. In addition, once you create your smart contract and deploy it, you can't change it, so testing is the developer's last chance to fix possible flaws and bugs.

To simplify testing, blockchains usually have test networks that allow you to test a smart contract without any risk of losing money, data, or reputation. The choice of test network depends on the blockchain. For example, Ropsten or Rinkeby work with Ethereum, while Hyperledger Fabric, based on permissions, requires Hyperledger Umbra.

Step 6: Contract deployment.

The last step in developing a smart contract is to deploy it in a blockchain environment. After that, your smart contract becomes available to users and cannot be changed. After that, to improve your smart contract, you will need to create and launch a new version, and the old version will continue to exist on the blockchain network as long as it works. Therefore, there are now three versions of Uniswap on the Ethereum network that run in parallel. 

Final thoughts

Anyone can develop and implement smart contracts. Everything required for it is just proper skills. However, even if you don’t have the right talent, you can always hire a team of experienced blockchain developers like Merehead. We can develop, test, and deploy a smart contract you require.

Three Types of Smart Contracts. How to Develop a Smart Contract? key takeaways:
  1. What are smart contracts?
  2. How do smart contracts function?
  3. Smart contracts vs. regular contracts
  4. Smart contract advantages
  5. Smart contract disadvantages 
  6. Three smart contract variations
  7. Smart Legal Contract
  8. Decentralized Autonomous Organizations (DAO)
  9. Application Logic Contracts (ALC)
  10. How to develop a smart contract?
  11. Step 1: Select a blockchain platform.
  12.  Step 2: Select development instruments. 
  13. Step 4: Smart contract development process.
  14. Step 5: Testing the smart contract. 
  15. Step 6: Contract deployment.
  16. Final thoughts
Merehead does professional development of smart contract development. If you have questions, contact us for a free consultation.

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