What are Smart Contracts? – Understanding contracts on the blockchain
Understand what Smart Contracts are and why they might replace a lot of lawyers
Smart Contracts are intelligent contracts based on blockchain technology. This enables different entities to digitally verify and enforce contracts without the need for a third party like a lawyer, notary etc.
Blockchain is widely seen as a speculative good that got famous because of Bitcoin. But the underlying technology is way more interesting in many ways. Smart Contracts are intelligent contracts that need no third party like a lawyer, notary or public official to verify, facilitate or enforce the contracts.
This literally means that you could make fast, reliable and credible transactions with any third party without the limitations of normal contracts – Yes, it could even cut-out the lawyer costs.
One of the most popular networks for smart contracts is Ethereum, but also Solutions on the classic Blockchain (or derivatives called Side Chains, especially for contracts), or other projects can be used. There are many different networks which can be used and every protocol has their own advantages/disadvantages as there will be always a trade-off between security (Data security and integrity), scalability (Speed, capacity, throughput and latency) and decentralization (Accessability, availability and transparency)
If you ever wondered how such a Smart Contract would look like, here is an example from an Ethereum based vending machine code:
8 Advantages of Smart Contracts
In the introduction I already mentioned some of the key aspects of digital contracts that are based on blockchain technologies. But the list of advantages is longer, and I give some insights so its easier to understand why Smart Contracts have such a big potential.
With every transaction it is important to have trust for both parties that this transaction really works out. Due to the unique way of storing information in the blockchain, many computers share the information and verify it indipendently, it is possible to used the socalled “distributed ledger” that this information is valid and also can not get lost. So the contract will be also there in the future and is unaltered.
Due to the mechanics of storing the information in the distributed ledger, it is also important to mention that there are many copies in the network. This ensures a redundant backup for all the documents created and all enforced contracts.
As the network is handling the hand-off and the contract terms, it is fully autonomous. For a successful transaction you don’t need a bank, broker, lawyer, regulator or other intermediearies. In this way you can set up your own contracts and you are not limited by local limitations or costs involved in the verification of the transaction.
Traditional contracts can take a lot of time to process, verify or even enfoce with third parties. Blockchain based Networks can speed up this process to just few hours or almost real-time transactions. This is especially improtant when you have small transactions you need to verify fast (Think of renting a car, travel insurence, etc.)
You can imagine that contracts that need no notary or whitness are less expensive. This is also applicable for Smart Contracts. When the contracts are being enforced and verified by the network instead of third parties, the cost per transaction gets lower. This is especially important to understand if you are looking to “tokenize” assets. Where you split big projects into small pieces. (e.g. Buying a share of a house)
A great advantage of Smart Contract is that they are “smart”. That means you can also ensure that complex structures of contracts are met and you have a tracability of the document but also goods. An example involves international shipping, where goods flow through different legislations, cross different borders, are insured with different insurers and all needs to be managed in a contract so its legit. This usually involves long contracts and much paperwork – which could be automated and tracked with a Smart Contract.
7. Encryption & Security
Another important role is of course the secure transaction. This doesn’t only mean that the document and the contract are reducantly stored, but also that the information is only accessible when someone is allowed. The use of very secure network protocols and Cryptography together with other security layers, ensures that only involved parties can access the information
8. Accuracy of contracts
Last but not least, there can be many mistakes when dealing with intermediaries or when dealing with manual paperwork. This can be a small factor but also worth mentioning, that there is a better overview and therefore also better accuracy for the enforced contracts.
Examples for Smart Contract Use-Cases
Due to the unique facts of Smart Contracts there are many industries and topics that might profit from these kinds of contracts and contract enforcement. I will list just some examples. For a more detailed list I reccomend this article: Blockchain – Possibilities, applications and use cases for the distributed ledger technology
Secure and trusted transactions have of course also governmental use. Especially when you think about applications that involve verifications in any way. Best example might be voting, it is critial to have a trusted vote to avoid voter fraud but on the other hand it is very complex to ensure this integrity when doing it offline. There it would be beneficial to introduce a digital identity that would allow only to cast one vote and is only available to the person itself.
– Supply Chains
Especially for bigger corporations which have a global network of supply chains involved, it can be beneficial to have a digital track record of every transaction. Therefore it is possible not only to have automation in the process but also trace back the product to every stage of its journey. This would increase the transparency, could help identify bottlenecks and also helps to manage lots of contracts.
Another scenario is, that exactly when the goods arrive, the payment is being processed. This gives the sender and also the receiver the security that the contract is being enforced as only the transfer of goods is possible when the payment is being processed. This means also no trade financing needs to be in place for such transactions.
– Real Estate
From transfering a property to a buyer to giving access to a property. Contracts are involved in every Real Estate transaction. Smart Contracts could help limit the risks and costs associated with them. E.g. you could rent out your appartment to someone for some days, his NFC chip only works as long as the payment is provided. When the renter didn’t transfer the money, he doesn’t have access to the property.
Also in Real Estate transactions it can be beneficial to only transfer the property when the payment arrives. With a smart contract you don’t need a middleman like a bank or notary to handle the payment and then only release the property, you can do it directly and without wait time.
I mention it here as it is a big topic for many countries. “Who has access to my patient data?”, “Is my digital patient file secure?” and many other questions arrise from having digital patient records. As we learned, Smart Contracts can be beneficial if only a limited number of persons need access for a limited time. This would also mean that you have your own personal record always with you and you only share it when you allow the doctor to see it for a certain time. The same goes with prescriptions, which can not be altered, testing results and also automatic insurance claims.
In highly regulated activities, like drug storage and delivery, the compliance costs can be high. Smart Contracts can ensure trust, traceability but also safe lots of administrative costs.
Downsides of Smart Contracts
Of course they are far from perfect and as it is based on software, there are also problems like potential bugs, cost of the network etc.
Another thing to mention is the missing regulation at the moment. Currently there are no real guidelines and laws regulating smart contracts. This means that there is also no backup. When you are renting your car with an automated blockchain contract, there was a mistake in the payment, then your car might be not accessible or even be rented to the next person before you can react – remember, there is no intermediary who could mediate.
Also it is worth to mention that these contracts perform, no matter what happened. If you set the wrong conditions, it will execute, no matter what happend.
This is also true with data-privacy. On the positive side is the fact that there is no data lost in the Blockchain, but when it comes to personal data, it can be also a downside. This is still an unsolved and open problem, that personal data can not be deleted.
Verdict for Smart Contracts
The development in the last years was fast and mostly driven by the upcoming speculations based on socalled cryptocurrencies like Bitcoin, Ethereum and many others. The applications for blockchain-technology based smart contracts were a little slower but also having first successful usecases implemented. With new platforms and easier to use networks we might see a better development and a broader adoption.
For many industries it is worth to have a look at potential applications. It is very important do identify the right usecase and which information needs to be stored on the blockchain. Maybe you want to secure transaction data and personal data (be aware of the data privacy problem!) but you don’t need to store large datasets like pictures and videos which might not be critial.
The key for successful use of this technology is to identify the processes, data, information and much more which is critial and where you definitely want it to be secure, decentralized and transparent but also trusted. Not everything is worth the effort and Smart Contracts are not perfect, so choose wisely!
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