PGPEM

APPLICATIONS OF
BLOCKCHAINS TO
SMART CONTRACTS

HAGAR SUDHA
MICROSOFT OFFICE USER

PGPEM 2018-2020 | IIM-B


Table of Contents
INTRODUCTION ............................................................................................................................. 3
What is Ethereum ? ...................................................................................................................... 4
What are Smart Contracts? .......................................................................................................... 6
Present state of Ethereum platforms ........................................................................................... 7
Performance of ether as a cryptocurrency .................................................................................. 9
Future directions of ether as cryptocurrency ............................................................................ 10
Microeconomics principle applicable to blockchains driven smart contracts .......................... 12
CONCLUSION .............................................................................................................................. 15
REFERENCES ................................................................................................................................ 16

2



INTRODUCTION

On the background of smart contracts, the term was first coined by Nick Szabo, a prominent
computer scientist, and cryptographer, who first proposed the idea in the 1990s.

Szabo realized that decentralized ledger technology could be leveraged for smart contracts,
which could be converted into computer code, stored, and replicated on the system under
the supervision of the computer network tasked with keeping the blockchain running, thus
smart contracts bring with it the elimination of human management and reduces risk that
would have otherwise existed with conventional contracts.

With the advent of technology contracts can be coded to communicate with each other,
exchange vital information, reflect what influences them, and stay updated with the most
current information.

Through the use of smart contracts, business will become faster and more flexible in the
current year and beyond:
• Offering the ability to learn from past contracts
• Providing an understanding of the risk-taking capacity of the organization
• Creating adaptable contracts that change with underlying assets

Blockchains that utilize distributed ledger technology require contracts that are self-
verifying, self-executing, and autonomous. Companies can exchange terms, events, and
information throughout the lifecycle of a contract without relying on brokers or middlemen.

For example, contracting parties can automate payments due over the lifecycle of a
contract. The nature of blockchains and distributed ledgers means that as these contract
milestones are reached and payments are made, they are recorded in such a way that
neither party can repudiate or manipulate the record.

Bitcoin was the first crypto currency to support basic smart contracts, since its network
could transfer value from one participant to another. Its programming language could
create smart contracts such as payment channels, escrows, multisig accounts, and time
locks, but is somewhat limited.

Ethereum, unlike Bitcoin was built with smart contracts in mind. It had a script language
that was more flexible in that it enables developers to build their own decentralized
applications. It is today credited with the most prominent smart contracts framework.

3

What is Ethereum ?

Ethereum is typically thought of as a cryptocurrency, but it is more than just a
cryptocurrency, its actually an open software platform built on blockchain technology that
enables developers to build and deploy decentralized applications.

Ethereum is a computer network run by the community of users, it means that personal
information of users will no longer be stored on the central servers of big companies. So the
possibility of hacking, selling information and disruption does not exist – thus making it
safer.

The biggest breakthrough with Ethereum is that any user can can use this platform,
distributed network to create and run decentralized applications. No permission is needed
because third parties are no longer required.

Ethereum platform consists of a cryptocurrency called ‘ether’ that is used to power
applications built on the Ethereum blockchain. Ethereum lets software applications run on a
network of many private computers (also known as distributed systems).

Any program that runs on the Ethereum Virtual Machine(EVM) is commonly referred to as
“smart contract”. The most popular languages for writing smart contracts on Ethereum are
Solidarity and Vyper, though there are others which are currently under development.

Ethereum community adopts standards that are helpful to developers. These are introduced
as Ethereum Improvement Proposals (EIPs), which are discussed by community members
through a standard process.

Certain EIPs relate to application-level standards (Ex: standard smart-contract format),
which are introduced as Ethereum Requests for Comment(ERC). Many ERCs are critical
standards used widely across the Ethereum ecosystem.

4


Ethereum platform

Ethereum Community forum

5

What are Smart Contracts?

Smart contracts could be considered as digital agreements that execute automatically based
on data that exists in the real-world. It’s best thought of as an “If-then statement”. If
condition A is true, then execute function B.

The example below brings in the clarity of smart contract:

Suppose Tom has put up house for sale through blockchain, and the payment has been
made in cryptocurrency. The renter received a receipt which is held in smart contract with
the following terms:
• Tom must give the renter a digital entry key by a specified date. If the key doesn’t
come on time, the blockchain releases a refund. If it does, the smart contract
validates and releases both the payment to Tom and key to the renter.

Here, smart contract works on the If-then logic, so the buyer can expect a faultless delivery.
If Tom gives the buyer the key, then he is sure to be paid. If the buyer sends a certain
amount of cryptocurrency, then the buyer receives the key from Tom.

The code cannot be interfered with either of the parties involved without the other knowing
since all the participants are simultaneously alerted and the code is open sourced, meaning
it is publicly viewable.

Smart contracts are used for many other applications beyond even reliability and efficiency
of real-estate payment collection. In any process that involves manual interactions between
the participants could be eliminated and instead be automated and the value can be moved
in real-time by blockchain rather than taking a number of days to settle them using
conventional banking. And above all, there is no charge to set up and deploy this
mechanism.

6

Present state of Ethereum platforms

Ethereum has gained international attention and traction since its release in the year 2015.
Especially from late 2017 and early 2018 there has been a massive increase in popularity
because of rapid price increases in the entire crypto-asset ecosystem.

There have been nearly 240 million transactions. At its peak on January 4th 2018, the
network processed 1.3million transactions in 24 hours.

To current date, 35 million unique addresses exist on Ethereum blockchain.

Ethernodes reports just under 17,000 nodes running the Ethereum blockchain in six
continents, hence this makes blockchain the most decentralized platform till date.

Ethereum blockchain is, without doubt, the most active smart contract platform in
existence. Of the 100 tokens by market capitalization, 94% are built on Ethereum and of the

7

top 800 tokens, 87% are built on Ethereum. Almost most of these tokens are “ERC-20
tokens”, which made possible the majority of the $5.5billion raised through token sales in
2017 and the $6.5billion raised in just the first quarter of this year (2019).

Ethereum developer community is the largest in the world at 250000.

Countries around the world have found ways to implement blockchain technology –
specifically Ethereum to benefit its citizens. Government of Brazil has announced its
intention to move the petitions and popular voting onto Ethereum. Canada is also testing
out Ethereum to provide transparency to the use of Government grants to ease citizens’s
concerns of misappropriation and corruption. In Switzerland, the city of Zug, has began
offering digital IDs registered on Ethereum in 2017.

To combat corruption and exploitation through transparent means Chile uses Ethereum to
track data and finances through energy grid, and data is available for every citizen to see.
Dubai is on the move to become an entirely integrated, blockchain-powere city by 2020.
We may see Government adoption of the Ethereum blockchain as its utility is proven across
the world.

As an open-source, turing complete, world computer, Ethereum can be leveraged by any
developer today to build her own series of smart contracts (i.e., decentralized application).
A site that tracks dApp development lists 1,552 launched dApps, though more are currently
in development. Dapps consist of everything ranging from everything to do with prediction
markets to gaming, and will continue to grow stronger as the network is improved upon.

Scaling of the Ethereum network is an important problem that has multiple solutions
offered by participants working in the community. “Casper protocol” has been rolled out to
solve this problem, to tackle the scalability, security and decentralization on blockchain.
“Cosmos” is a permission less network built for developers that allows blockchain
interoperability and scaling. “Loom network” has developed and launched a layer 2
platform on top of Ethereum, allowing gaming and social dApps to scale while still relying on
Ethereum’s core security and decentralization.

Cryptozombies, a live app enabling anyone to learn to code smart contracts on Ethereum
(with over 200,000 students). Layer 2 scaling solutions have also been provided for
performance, but not safety.

Compared to 2018, ICO inflows and outflows are heading downwards compare to the
beginning of 2018, but are slightly increasing again. This selling pressure for the ICO holdings
will continue until a new token offering will enter the market. ETH holdings in ICO have been
declining, but decentralized finance ETH holdings have been on the rise again. Also, several
Dapps on the Ethereum platform are increasing in popularity which brings growing
transaction volumes.

8


Performance of ether as a cryptocurrency

The performance of Ether as cryptocurrency as of September 2018 has been shown below:

One, perhaps unforeseen was that Ethereum’s smart contracts enabled the Initial Coin
Offering(ICO). Unfortunately, many ICOs revealed themselves to be little more than money
making scams. Many ICOs released white papers and Ethereum based tokens with no
intention of ever delivering a working product – may never did.

Its facing challenges on many fronts – Scaling woes, governance issues, and platform
updates.

Ethereum’s price was positive in 2017, but it was not the same in 2018. In 2017, Ethereum
closed the year having made gains of over 8000%, however its trading price dropped by 90%
over the course of the year.

In January, Ethereum had to delay a long awaited hard fork following security concerns over
updates to its smart contracts. Had the update happened, the vulnerability would have
allowed attackers to exploit smart contracts to steal funds from them by interacting with
contracts numerous times.

Ethereum is also facing usership issues. Of the top 50 dapps on DappRadar.com, only three
use the Ethereum blockchain. Many developers favour the EOS and TRON platforms. It also
looks like dapps are migrating because of the continued scaling woes that Ethereum is still
in the process of addressing.

However, Ethereum hopes to bypass online giants such as Amazon, Facebook or Uber by
allowing automated agreements to guarantee users a service.

Future directions of ether as cryptocurrency

Just like the other blockchains that exist in public domain today, Ethereum intends to
support as many users as it can possibly do.

But, the problem they often stumble upon is that it’s tricky to preserve this balance while
also growing the number of users, this problem is primarily faced because Ethereum
depends on a network of ‘nodes’, each of which stores the entire Ethereum transaction
history and the current ‘state’ of account balances, contracts and storage. This becomes a
cumbersome task because the total number of transactions is increasing approximately
every 10-12 seconds with each new block.

But the solution seems that to raise the blocksize to fit more transactions, but this will
require more resources and come to a point where only a few large companies can
accommodate them, hence making scaling a big issue in Ethereum.

Ethereum in future is looking at ‘cryptoeconomic incentives’ in this nodes are passing only
valid information to other nodes thus storing only subsets of data in the nodes.

In a distributed consensus-based on the proof of work, miners need a lot of energy. One
bitcoin transaction required the same amount of electricity as powering 1.57 American
households for one day, and these costs are paid with fiat currencies leading to constant
downward pressure on the digital currency value.

Hence, Ethereum community wants to exploit the proof of stake method for a greener and
cheaper distributed form of consensus. Also reward for the creation of a new block are
different: with proof of work, the miner may potentially own none of the digital currency
he/she is mining. But, on the other hand with proof of stake, forgers are always those who
own the coins minted.

10

Transition to Ethereum 2.0 (Serenity) is aimed at making Ethereum better and faster. The
final completion date is set around 2021, Ethereum has come up with fastest and ad-free
blockchain explorer, EnjinX, which would definitely make ETH more accessible to the
mainstream market.

Ethereum’s strength in comparison to other cryptocurrencies is the computing language
that allows the ‘smart contracts’ and ‘crowd-funding campaigns’ to exist that makes
Ethereum more valuable than others, so in future there will be more smart contracts that
would be realized using ETH. However, there are many other smart contracts that exist
today and hence Ethereum has to fix the many issues that its platform has else it could
loose out to its competitors, this has been quoted because researchers from Singapore and
the UK have found 34,000 Ethereum based contracts susceptible to bugs and security
breaches.

Smart contracts would breakdown the barrier between traditional financial products and
blockchain technology. Physicians who are part of the Medicalchain platform will have
access to read and write to a patient’s medical record with access secured by the
blockchain. Ethereum could look into expanding via smart contracts into Supply chain, by
using smart contracts to track global supply chains companies can work across borders and
still offer more robust services to enterprise clients.

ICO’s are validated by the Ethereum blockchain, meaning without Ethereum other tokens
cannot exist. This positions Ethereum to become one of largest cryptocurrency companies in
the world.

The profitability of computer operators who validate transactions is deemed by some
analysts to favour those who run their own hardware as opposed to relying on cloud
services in the near future.

Ethereum might rise with strong capitalization and consequently a concrete value per coin
increase. It might also experience frequent ups and downs in the 1st and 2nd quarter. From
the third quarter, it will start growing at a steady pace from $484 in July to around $1449.89
in 2019.

11


Microeconomics principle applicable to blockchains driven smart

contracts

Blockchain (or distributed ledger system) and microeconomics both are large-scale
distributed systems, and there are inherent connections found between them.
In principle, a blockchain system (including various nodes such as full node, mining node,
and lightweight node) and a microeconomic system (including a social system, which
consists of producers, consumers and markets) have many similarities: different
interconnected subsystems, decentralized computations and so on.
The broad concern of microeconomics is to allocate scarce resources among various users
with the goal of maximizing user’s utility and producer’s profit just like in the case of
blockchains.

Markets are often efficient governance institutions for spot contracts (a pure exchange
economy) but when an economic activity requires coordinated investment through time
(asset specificity), or an ongoing relation between parties (frequency), or involves
uncontract able dealings (uncertainty), alternative governance institutions like Ethereum
platforms can be used to deal with the effects of opportunism (in game-theoretic terms)
since programmatically it automates the process between the parties involved based on
actions by each parties which then triggers the next steps in the algorithms to finally come
to a consensus if the party on the other hand has had a breach or not, hence there is
consensus and transparency in Ethereum platform which eliminates opportunism.

Blockchain enabled smart contracts facilitated transactions should experience less of the
efficiency problems of information asymmetries – adverse selection and moral hazard
since the smart contracts exist in the public domain and are completely transparent.
Also, since smart contracts exist in ethereum platforms, costly signalling could be easily
avoided or even screening, it all happens automatically.

Since, Ethereum functions like open source libraries that could simply be inserted into
machine readable contracts, the complexity cost of writing contracts could scale linearly and
hence the blockchain would have lower transaction costs from a microeconomic viewpoint.

Also, we can say that a blockchain is a ‘trustless commons’ in which effective rules are
embedded in constitutional smart contracts that are made secure by cryptographic and are
implemented crypto-economically.

Talking about blockchain mining, it generates economies of scale and creates a positive
feedback loop between network effects and security: as more participants use a crypto
token, its value increases which in turn attracts more miners (due to higher rewards),
ultimately increasing the security of the shared ledger. Similarly, on the other hand if the
confidence in a crypto token drops like ETH, it would destroy the value of the underlying
cryptocurrency and hence miners could leave the ecosystem because of the lower rewards
until the point where the ledger becomes insecure and is rendered useless.

12


As seen above, on the horizontal axis, quantity could be assumed as the number of
transactions that can be cleared. On the vertical axis is the miner’s fee in Bitcoins. The orange
demand line is the number of transactions that market participants want to clear and blue
supply line is hash power supplied by miners to clear the transactions.

The red vertical line denotes the quota of 1 MB block size. Since the inception of bitcoin, the
quota line has always been firmly to the right of the equilibrium point. This means there was
never enough demand to fill up the blocks so the quota actually didn’t matter economically.
But once the quota goes to the left of the equilibrium point (the current scenario), things
begin to change. The red area in figure 3 is the dead weight loss. It represents transactions
that would have been valuable to both the miners as well as traders but cannot be executed
because of the block size quota. This is the economical value which is lost forever.

Also, we see a difference between the producer price and consumer price when the quota is
applicable. So consumers - in this case the bitcoin traders - end up paying more than what it
takes to validate their transactions. This cost to consumers is not necessarily monetary, but
the time they spend waiting for their transactions to be validated.

Mining small blocks is indeed profitable to miners if the fee density of transactions in
mempool is low. However, this increases the dead weight loss to the system as a whole and
could lead to phenomenon similar to ‘tragedy of commons’. Having a fixed fee density
(something similar to gas while deploying smart contracts in Ethereum blockchain) could be
an interesting approach to incentivise miners to include maximum transactions in block, but
the downfall being that transactions couldn’t be prioritized.

13


As seen above, the basic supply-demand graph stands the same for Ethereum
cryptocurrency. On the vertical axis is the price of a product per unit and on the horizontal
axis is the quantity per period. The blue and orange lines simultaneously show supply and
demand. The point of intersection of these two lines gives the equilibrium point.

The orange shaded region in the graph is consumer surplus which is derived whenever the
price paid by the consumer is actually less than what the consumer was willing to pay.
The blue shaded region in the graph is producer surplus which is the additional private
benefit to producers, in term of profit, gained when the price they receive in the market is
more than the minimum price they would be prepared to sell for ETH.

On the platform of Ethereum, Dutch auction was used by Gnosis to sell tokens and they
reached their goal of 250K ETH in less than 15 minutes. Meanwhile, the popular game
CryptoKitties is using Dutch auction to sell their cats. We can imagine that Dutch auction will
be used in more and more smart contracts to figure out the optimum price of various
commodities.

14

CONCLUSION

In conclusion, Ethereum is an improvement of bitcoins, with better technology and having
the smartest people in the world working on them. Ethereum will have a positive impact as
time progresses on the economy as a whole.

Ethereum could potentially help Governments, entrepreneurs, financial companies and
intermediaries and healthcare departments alike and at the same time with the smart
contracts as the major strength of Ethereum it could educate and encourage public
participation to use it to prevent additional costs and manual intervention in a world where
everything today is driven by the amazing possibilities that technology has to offer.

Ethereum is definitely going to taste success in the coming years as it has in the past, but
what we look forward to is the reduction in energy consumption and building efficient
systems that are scalable with increased participation by the public and Government.

Smart contracts have to be still dealt with caution since its easy to find breaches if not
explicitly stated during design of contracts, and it may have external dependencies to work
for most things in some complex smart contracts, so we have to tread with caution as there
is still scope for improvisation of smart contracts in Ethereum itself though they were the
pioneers of smart contracts.

But for sure, smart contracts will revolutionize the world!!!

15


REFERENCES

https://www.icertis.com/blog/blockchain-smart-contracts-will-change-contract-
management-2018/?icid=70137000000Enu9AAC&gclid=CjwKCAjwq-
TmBRBdEiwAaO1en1CgooqAz1TDj9DlGBJVyWw4kQI3P4A5LVkc-
NGOu5ElrupKyC_isBoC8mUQAvD_BwE
https://education.district0x.io/general-topics/understanding-ethereum/what-is-ethereum/
https://www.ethereum.org/build/
https://www.ethereum.org/build/#smart-contract-languages
https://blockgeeks.com/guides/smart-contracts/
https://education.district0x.io/general-topics/understanding-ethereum/what-are-smart-
contracts/
https://media.consensys.net/the-state-of-the-ethereum-network-949332cb6895
https://thenextweb.com/hardfork/2019/05/01/ethereum-performance-q1-2019-etoro/
https://www.theatlas.com/charts/BJ7B4P8u7
https://blockonomi.com/ethereum-price-prediction-2019/
https://cryptoinsider.com/examples-real-world-uses-smart-contracts/
https://readbtc.com/7-smart-contracts-to-consider-2019/
https://www.genesis-mining.com/future-of-ethereum
https://www.mangoresearch.co/ethereum-casper-v2-beacon-chain-sharding-explained-
simply/
https://www.coindesk.com/staking-ethereums-mining-alternative-will-be-profitable-but-
barely
https://blog.blockonomics.co/the-economics-of-bitcoin-block-size-e9575272c3ee
https://medium.com/platform-innovation-kit/how-blockchain-will-transform-the-platform-
economy-part-1-e5994de8663d
https://medium.com/secbit-media/smart-contract-and-nash-equilibrium-3ef947d87042

16