Individuals who use the Ethereum blockchain have regularly come across these two terms: smart contracts and decentralized applications (dApps). However, despite hearing these names frequently, both concepts feel new and complicated to most casuals in the blockchain space. Although they are relatively new cryptocurrency features, smart contracts and dApps are becoming the backbone of most blockchain products.
Decentralized applications and smart contracts are both deployed on blockchain networks. dApps often use smart contracts for operation. These contracts are automated digital agreements on a blockchain that run on preset terms and conditions.
This guide will explore the concepts of dApps and smart contracts along the following lines: definitions, how they work, utility, and benefits.
Estimated reading time: 6 minutes
Table of contents
What Is Ethereum?
Ethereum is a decentralized, open-source blockchain network that allows the creation of dApps and smart contracts. Its native currency, Ether (ETH), is commonly used by investors for digital currency transactions; however, its functions go beyond a financial store of value.
ETH is used to pay for transaction fees called “gas” and the power dApps and smart contracts running on the blockchain. Ethereum is designed to be scalable, programmable, and secure, meaning anyone can use the network to develop a digital product.
What Is a Smart Contract?
Smart contracts are the same as contracts in the real world but in digital form. Simply put, a smart contract is a computer program that runs on blockchain technology and is designed to execute when the parties involved meet the predetermined conditions.
For example, a smart contract can be set to issue a digital key to the apartment once a tenant meets the rent terms. If the terms are not met, the smart contract will not execute. Smart contracts are immutable; once published on a blockchain, they cannot be changed, deleted, or altered and are visible to blockchain participants.
How Do Ethereum Smart Contracts Work?
A smart contract automates the execution of a specific protocol when the preset condition is triggered. These conditions are pre-written and automatically implemented once activated by the required party. Smart contracts are applied in various fields such as financial services, insurance, gaming, and supply chain management.
For example, a smart contract process follows steps to execute a transaction in the digital environment:
- The vendor and buyer will negotiate the terms of the sale, including the fee and date of delivery.
- The buyer then sends the agreed fee in Ether (ETH) to a smart contract address.
- After that, the smart contract code validates the condition of sale; this could be the receipt of the agreed fee.
- If the conditions are met, the smart contract automatically implements the terms of sale. In this case, it will transfer product ownership to the buyer.
- Once this is done, both parties have been satisfied as the smart contract has fulfilled and enforced the agreement.
- The details of the deal are permanently recorded on the Ethereum blockchain, making it immutable.
Key Benefits of Smart Contracts
Smart contracts offer numerous benefits that make them relevant in the blockchain space :
- Security and immutability: Smart contracts use advanced cryptographic systems to guard against unauthorized access and hacks. Once deployed, the sophisticated encryption techniques help reduce the risk of potential malicious activities. However, this immutability also poses a smart contract risk as errors and oversights cannot be corrected after deployment. Due to blockchains being decentralized and distributed, smart contracts could be an ideal solution for managing sensitive data and conducting financial transactions.
- Efficiency: Smart contracts eliminate the potential delays and hurdles common with traditional procedures. Its ability to run without human supervision also cuts out middlemen, thus reducing transaction costs and other associated fees. This automation also accelerates the speed at which tasks can be done, thus improving user experience. Companies with high transaction volumes or cross-border operations can leverage this efficiency for enhanced operations.
- Transparency: Any smart contract transaction is published on a blockchain and visible to network participants. This means it can be verified and tracked by any member of the blockchain. Through smart contracts, a blockchain enforces the terms of an agreement without using intermediaries.
According to a Deloitte survey report, over 70% of senior officials expect smart contracts to become increasingly significant in the financial space soon. Meanwhile, the Ethereum decentralized finance market (DeFi) has grown significantly in the past few years to become a $40 billion sector. The above trend reinforces the growing adoption of Ethereum smart contracts and its position in shaping the future of global finance.
What Are Decentralized Applications (dApps)?
Decentralized Applications, or dApps, are applications that use blockchain technology instead of a centralized server. dApps run on decentralized peer-to-peer networks, enabling them to operate in a trustless manner. In traditional applications, transactions and data are logged in centralized servers and require human oversight. These setups are more prone to human errors and possible server hacks.
On the other hand, decentralized apps use distributed networks to store and process data, which means that the “backend” cannot be traced to one source. Hence, this approach makes them immune to breaches and server downtime.
Examples of dApps include DeFi platforms, NFT marketplaces, decentralized social media platforms, and decentralized gaming.
How Decentralized Applications Work
dApps operate on a preset consensus mechanism, such as proof of stake or proof of work, which forms a framework for an automated decision making process.
- Proof of stake: The proof-of-stake consensus mechanism validators are chosen based on the quantity of their stake in the dApp or network. As such, decision making power is conferred based on the stakes of an ecosystem member.
- Proof of work: The proof-of-work consensus mechanism selects network validators based on computing power. Decision markers are ranked by the number of cryptographic works done by users.
Key Benefits of dApps
Decentralized applications offer several advantages in numerous fields, some of which include:
- Decentralization: dApps run on decentralized networks without any centralized control. This approach eliminates the risk of failure or downtime if a single point is breached. Moreover, network participants, known as nodes, are tasked with running the application, and no single member can make a decision without consensus. Additionally, all data is published on the network and can be easily verified and tracked by its participants.
- Open-Source Transparency: Most decentralized applications are open source; anyone can audit, inspect, or become a network developer. Since dApps are open source, their community can easily identify and patch vulnerabilities. Consequently, this drives innovation and the implementation of these applications.
- Cryptographic Security: dApps enforce security using the cryptographic protocols of a blockchain. Hence, every transaction is encrypted, validated by a node, and immutable.
- Autonomy and User Control: Unlike traditional apps, dApps grant users autonomy over their personal information and offer direct network interaction through smart contracts.
How Decentralized Applications Use Smart Contracts
dApps leverage smart contracts on the backend to automate protocols and create trustless environments. Hence, transactions and terms within the blockchain can be implemented automatically based on preset rules. At its core, decentralized applications on Ethereum use smart contracts to automate processes, enforce agreements, and enable peer-to-peer interactions without human intervention.
Bottome Line
dApps and smart contracts have become part of everyday blockchain conversations. Industries such as finance, gaming, and supply management are already benefitting from the efficiency, security, and scalability offered by dApps and smart contracts. As blockchain technology continues to gain relevance, these two concepts could transform digital interactions in several sectors.
