Bitcoin Ecosystem: An Overview of Bitcoin Smart Contracts and How They Work

bitcoin smart contracts, in terms of their basic design and architecture, exist on a separate blockchain (stacks) and leverage the security and latent capital of bitcoin through a unique consensus mechanism called proof of transfer . all of this occurs without altering bitcoin itself. Let’s get into how they work.

so what exactly is a smart contract?

Smart contracts are blockchain programs designed to execute autonomously when predefined events or actions occur. the terms of a smart contract are specified in the code to eliminate the need for human execution, arbitration, or enforcement, and since that code is stored on the blockchain, the terms of the contract cannot be altered.

Reading: Bitcoin smart contracts

bitcoin smart contracts, like other smart contracts, guarantee trustless transactions. but beyond that, those transactions are ultimately settled in bitcoin, making transaction history more durable through bitcoin’s battle-tested security.

Interestingly, bitcoin was not originally designed with smart contract functionality because it was designed to be a decentralized currency. that required an emphasis on both security and decentralization, and to achieve that goal, bitcoin had a limited scripting language to reduce the surface area of ​​potential vulnerabilities. it made the currency more secure but also limited its programmability. stacks now function as the smart contract layer for bitcoin, allowing developers to write fully expressive smart contracts that take advantage of bitcoin’s security.

example of working bitcoin smart contracts

Bitcoin smart contracts can execute complex, predetermined multi-step transactions. Let’s take a look at an example and see how a bitcoin smart contract can work in practice.

arkadiko is a bitcoin defi app that allows users to get a self-repaying loan in usda (a stable coin) that is backed by their stx tokens. this is how it works at a high level.

  1. a user deposits stx tokens in an arkadiko vault as collateral.
  2. the user can then borrow usda, in an amount less than or equal to 25% of the initial value they deposited.
  3. the requested usda is sent to the user’s wallet.
  4. when depositing to the vault, the user can choose to accumulate the stx collateral via the stack transfer proof mechanism to get btc yield.
  5. that the yield of btc pays the usda borrowed. when the usda loan is paid off in full, the assets in your vault are unlocked and can be withdrawn by the user.
  6. in case the loan is not paid off, or the secured loan falls below the payoff threshold , the user’s assets are sold at auction until the debt and penalties are covered.

The reason I list all of these steps is to point out that all of this complexity happens autonomously. there are no individuals signing at different stages. More importantly, this also means that people cannot interfere with or manipulate the process. that is the power of smart contracts.

why do bitcoin smart contracts need a gas asset?

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Bitcoin smart contracts on the stack blockchain use the stack token (stx) as a gas asset to pay for smart contract execution. someone needs to execute, verify and store transactions, and the calculation is not free. you need a way to incentivize miners to provide that computation for the network.

If miners are not incentivized, they won’t do the work and the network will stagnate. gas assets are necessary for an open mining network to succeed. the network determines what the gas asset price would be for a smart contract transaction based on the supply and demand of the network’s processing capacity, among other factors. For example, during the launch of a new app or a popular nft mint, the network may become congested and some users may be willing to pay higher fees to have their transaction verified sooner than others.

Gas fees help prevent spam transactions from clogging up the network and give miners a rational reason to participate: they are compensated in the gas token for their computing work. competitive pricing, in turn, leads to the emergence of a robust fee market, which is a sign of a healthy blockchain network. open smart contract networks require gas assets to create open and healthy markets and that is why stacks has the stx token. As a side note, without a gas asset, it is still possible to create a network that works in a closed federated system, but that comes with its own risks. in that scenario, you enter a centralized model, and there are security risks that come with that.

three key benefits of bitcoin smart contracts

Bitcoin is the most secure and decentralized blockchain network in the world right now: it has never been hacked, and the financial resources required to pull off a successful attempt make such an endeavor unfeasible. Beyond this battle-tested security, below are three key benefits of bitcoin smart contracts.

1. programmability

One of the great benefits that bitcoin smart contracts provide is that they make bitcoin programmable for developers. there is a ton of dormant capital in bitcoin with a market capitalization currently hovering around $800 billion; however, most of that bitcoin is sitting there, hodling. for example, less than $15 billion of that total is locked in defi. and most of it is wrapped in bitcoin on other blockchains instead of native bitcoin defi. that’s changing.

stacks enables bitcoin smart contracts through the clarity programming language. clarity can read and react to the global state of bitcoin, meaning you can have trustless native exchanges, from bitcoin to other assets, all powered by bitcoin transactions on the bitcoin block chain.

Clarity brings two additional strengths to the table that are worth mentioning here:

  1. clarity is a decidable language, which means that the language is predictable and easier to reason about. this makes the smart contract debugging process easier for developers.
  2. clarity is an interpreted language and is not compiled. By design, the human-readable source code for each smart contract is available on the blockchain, effectively turning the blockchain into a “github for smart contracts.” this means that any user can verify what a smart contract will do, and everything in the ecosystem is transparent.

Through stack-powered bitcoin smart contracts, developers can create new applications that allow users to do more with their bitcoin than just store it.

2. lack of confidence

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The most powerful feature of a smart contract is its trustless execution. The lack of trust in smart contracts means that you do not have to trust a third party, such as a bank, a person or any other intermediary, in your transactions. instead, you trust the code. The lack of trust in smart contracts is one of the factors behind the growing popularity of nfts in the art world, where artists (and collectors) can ensure the digital scarcity of their work, authenticate its originality, and ensure residual income. perpetual payments from the resale of said assets. without a centralized intermediary.

However, for “trustless” systems to gain mass adoption, the system must be protected from tampering. you still have to trust the code and the underlying blockchain. this is where bitcoin shines.

the bitcoin network is open: anyone can contribute to bitcoin and anyone can become a miner. Over the years bitcoin has grown to have a large decentralized network of miners and developers globally. By design, it is virtually impossible for miners or users to collude to alter the status or ledger of bitcoin. this inherent immutability gives bitcoin smart contracts a secure foundation.

3. profitability

bitcoin smart contracts are more profitable than ethereum smart contracts. Gas fees, which incentivize miners to confirm transactions and keep the network operational, are often astronomical on ethereum and can make small transactions worthless.

So far in 2022, average bitcoin transaction fees peaked at $4.46, while average ethereum transaction fees peaked at $52.46, a staggering 1076% difference . and because smart contracts are accumulated in bitcoins in batches, the individual fee for a bitcoin smart contract is much lower on average than a transaction in bitcoin (with a current average fee to date of .3 stx, or very below $1).

If you’re building a web3 application with lots of user transactions, it’s only natural that you’d be concerned about your users’ willingness to pay high fees. If users are not willing to pay high fees, you will sacrifice user adoption if you build your app on a blockchain with high fees. For developers who are concerned about the financial costs of running smart contracts, the bitcoin network offers a cost-effective alternative.

leverage the power of expressive bitcoin smart contracts

Bitcoin has revolutionized the world of finance by demonstrating how money can exist and function outside of the direct control of governments and banks. now, thanks to stacks and the clarity programming language, bitcoin can extend its disruption as developers create fully expressive smart contracts to create new types of decentralized applications and use cases. welcome to a future denominated in bitcoin.

Looking for a home for your blockchain application? download our free guide to web3 ecosystems in 2022.

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