What Is A Smart Contract

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In this article I take a look at Smart Contracts. Smart Contracts have taken a center stage as one of the applications of blockchain technology. Although it is widely accepted that they have great potential to change the way business is conducted globally, there still remains a low understanding of the concept. This article attempts to give an understanding of the concepts surrounding Smart Contracts, the potential, challenges, and future of smart contracts.

History of smart contracts

In 1994, Nick Szabo, a legal scholar and cryptographer realized that the decentralized ledger could be used to convert contracts to computer code so that they could be stored and replicated on the system and supervised by the network of computers that run the blockchain. He introduced what he called smart contracts, also known as digital contracts or self-executing contracts.

Definition of smart contract

A smart contract is a computer protocol intended to digitally facilitate, verify, or enforce the negotiation or performance of a contract. Smart contracts allow the performance of credible transactions without third parties.

What do smart contracts do

Smart contracts facilitate the exchange of money, property, shares, or anything of value in a transparent, conflict-free way while avoiding the services of a middleman. Not only do smart contracts define the rules and penalties around an agreement in the same way that a traditional contract does, they go a step further and automatically enforce those obligations.

How do smart contracts work

Suppose John wishes to buy a song from Jane. He can do this through the blockchain by paying in cryptocurrency. He will then get a receipt which is held in a virtual contract; Jane then sends the song digitally with the understanding that it should reach John by a specified date and time. If the song doesn’t arrive on time, the blockchain releases a refund to John. If Jane sends the song before the agreed time, the functions holds it releasing both the fee and the song to Jane and John respectively when the date arrives.

Both Jane and John can expect a faultless delivery because the transaction is witnessed by hundreds of people within the network and the contract code cannot be interfered with by anyone without the parties involved being alerted.

Use cases of smart contracts

Smart contracts can be used for all sort of situations that range from financial derivatives to insurance premiums, breach contracts, property law, credit enforcement, financial services, legal processes and crowdfunding agreements.

While the stance of governments, financial regulators and banks worldwide on cryptocurrencies has been ranging from extremely cautious to carefully accepting, the technology behind them - Blockchain and smart contracts - has been widely accepted as revolutionary and it is being implemented across all levels.

For example, the Depository Trust and Clearing Corporation (DTCC) and four major banks - Bank of America Merrill Lynch, Citi, Credit Suisse and J.P. Morgan - successfully traded credit default swaps on the Blockchain developed by Axoni, using smart contracts.

In healthcare, personal health records could be encoded and stored on the blockchain with a private key which would grant access only to specific individuals. The ledger, too, could be used for general healthcare management, such as supervising drugs, regulation compliance, testing results, and managing healthcare supplies.

Benefits of smart contracts

Autonomy — Smart contracts give you full control of the agreement by doing away with the need for a third-party intermediary of facilitator. Incidentally, this also knocks out the danger of manipulation by a third party, since execution is managed automatically by the network, rather than by one or more, possibly biased, individuals who may err.

Trust — No one can steal or lose any of your documents, as they are encrypted and safely stored on a secured, shared ledger. Moreover, you don’t have to trust people you’re dealing with or expect them to trust you, as the unbiased system of smart contracts essentially replaces trust.

Savings — Notaries, estate agents, advisors, assistance and many other intermediaries are not needed thanks to smart contracts. This results in savings as you will not have to pay the fees associated with their services.

Safety — If implemented correctly, smart contracts are extremely difficult to hack. Moreover, perfect environments for smart contracts are protected with complex cryptography, which will keep your documents safe.

Efficiency — With smart contracts you will be saving a lot of time, normally wasted on manually processing heaps of paper documents, sending or transporting them to specific places, etc. You’d ordinarily have to spend chunks of time and paperwork to manually process documents. Smart contracts use software code to automate tasks, thereby taking hours off a range of business processes.

Accuracy – Automated contracts are not only faster and cheaper but also avoid the errors that come from manually filling out heaps of forms.

Problems with smart contracts

In theory, smart contracts sound efficient. But there are several problems related to their implementation.

For starters, smart contracts assume ideal actors, economic incentives, and perfect legal settings. That may not always be the case. In the example above, a legal problem would arise if Jane sends John an empty file in attempt to defraud him. Because smart contracts can be executed without a physical meeting, the potential for a fraud or misrepresentation is high. Then there are other problems pertaining to smart contracts, such as, who is responsible for coding errors or if the system malfunctions due to certain conditions?

Enforceability And Jurisdiction

But the two biggest legal problems of smart contracts lie in their blockchain provenance. The first one is the enforceability of smart contracts. Blockchain came into mainstream prominence as a decentralized and permission-less system that can be used to speedily conduct business transactions between multiple geographies. Current dispute resolution of contracts differs between countries and is settled in courts. There is also the problem of jurisdiction. How will disputes involving smart contracts for international transactions that span multiple geographies be resolved?

Other challenges are around government regulation. How should governments regulate such contracts? Or, how would governments tax these smart contract transactions?

From a programming perspective, a smart contract once deployed cannot be destroyed until it executes or until time elapses. The tiniest mistake can prove to be very costly as it will still execute as programmed without an option to alter the terms therein.

For many small businesses, another challenge smart contracts present is their creation and registration. Most smart contracts are written in the Ethereum programming language which few business owners have the time and inclination to learn. Fortunately, there are resources available, such as Modex, Zeppelin Solutions and Applicature, which can help you transform a traditional agreement into an enforceable, registered smart contract. All you need to do is define your agreement terms, and these companies can manage the process from there.

Future of smart contracts

Smart contracts aren’t just the future of business; they are already in play. These agreements save time and money while improving communication and transparency. While keeping in mind that the technology is still in its nascent stages, it is not difficult to see that smart contracts can play a vital part in many industries. Governments, insurance companies, real estate businesses, and more, can benefit from the use of smart contracts to reduce the consumption of resources.

Conclusion

Smart contracts support the global economy by streamlining transactions. Even the most basic business contract requires a lawyer or a broker to oversee its completion; and meeting the terms of the agreement necessitates additional actions such as invoicing, delivery scheduling and payment.

Smart contracts eliminate the middleman and allow the two parties to define their own terms. First, the contract is registered with a database and is legally cleared as a valid agreement. Each step of the contract is then automated and triggered to be completed when a specific event occurs.

Smart contracts can streamline processes across nearly every small business. These contracts can assure that your company has the resources it needs to fill orders, or the information that's needed to deliver a service.

Sources: www.investopedia.com | www.blockgeeks.com | www.cointelegraph.com | www.blockchainhub.net | www.entrepreneur.com

The author is a Certified Blockchain Expert and a member of Crypto Tamanga, a community of blockchain technology and cryptocurrency enthusiasts in Zambia.