What are smart contracts and why your business needs them
Tags: Digitalization, Digital Transformation, Blockchain, Smart Contracts, Business Strategy

One of the biggest breakthroughs in technology in the last decades is without a doubt the invention of smart contracts. Their history goes all the way back to 1996 when Nick Szabo coined the term. But the first time they were brought to life on a large scale was to back up the transactions on the Bitcoin blockchain in 2008. Since then smart contracts secured billions of dollars in transactions and were also implemented in a number of other industries.

Here’s a simple example:

Contrary to a popular belief, smart contracts have very little to do with the contracts in the conventional sense. They are just digital agreements that automatically fulfill themselves, so you don’t need an intermediary to approve all the operations.

In a nutshell, smart contract is a software that lets transactions occur only if certain criteria are met. These contracts are programmed instructions that let the system know how to behave in which situations. The technology behind smart contracts made it possible to exchange money, shares, property or any other goods in a transparent way that doesn’t leave room for middleman and human error.

Imagine, I’m selling an online course on a blockchain-powered platform. If you want to buy it from me, we enter into a smart contract. As soon as you signed up for my course, the system is ready to go. It checks if it has access to the product (my course) and waits for your payment.

It knows that it can send you my files only after you transfer the right amount of money. If you send me the money and the system can’t access the files of my course, it will refund you. If the smart contract sees that you didn’t send enough money — it won’t send the files.

When all the criteria for a successful operation are met — smart contract completes it. And if the criteria aren’t met, it will simply return your money or goods to you. So both parties engaging in a deal can be sure that they won’t be tricked.

Here’s how Vitalik Buterin from Ethereum explained it during a DC Blockchain Summit:

In a smart contract approach, an asset or currency is transferred into a program. The program runs this code and at some point it automatically validates a condition. It automatically determines whether the asset should go to one person, back to the other person, whether it should be immediately refunded to the person who sent it or some combination thereof.

Benefits of smart contracts

According to Szabo, the four main areas smart contracts improve are:

Observability — everyone with a copy of a blockchain can see the transactions that happen on it.

Verifiability — it’s really easy to confirm that the transaction took place and that it was successful.

Privity — legally binds the two parties of the transaction not letting a third-party to impose its obligations.

Enforceability — the conditions of a smart contracts have the potential to be enforced in court if the right laws are passed. For example, this bill in Vermont.

I think that these alone are enough reasons to look into implementing smart contracts for a business. But let’s dig a bit deeper into the benefits of this tech.

Cutting costs and increasing speed

With automation of paperwork and removal of intermediaries, a lot of time and money can be saved. Of course, developing and implementing proper smart contracts requires resources, but in exchange you significantly reduce operating costs and eliminate the mistakes made by humans.

Speed is one of the sore points for smart contracts. Historically, the transaction speed isn’t that high, due to complex processing that needs to take place. But again, that doesn’t compare to the time consumed by paperwork in conventional institutions.

In addition, the recurring costs are minimal, since once the system is up and running, all you need is basic maintenance.

Autonomy of smart contracts

Once the smart contract is set up, there’s no need for an initiator to take part in its operations anymore. In addition, the initiator often doesn’t even have to use that much server space to store this software and run transactions, since the smart contracts are often distributed across many machines in a blockchain network.

Trust

Smart contracts are perfectly developed for systems in which parties don’t trust each other. Usually, you’d need an intermediary everyone trusts to manage communication and deal making. Now there’s no need for that. The deal will happen only if all the parties comply with the set conditions.

Accuracy

If the smart contract is developed and tested with enough cautiousness, it is certain to do exactly what it’s programmed to do. Needless to say that there’s no bribing or convincing the software that you need that loan if you don’t match the criteria it was set to follow.

Industries that can benefit from implementing smart contracts

Smart contracts aren’t only great in theory, they are already being implemented in high-profile business domains and a lot of new use cases are on the way. Here are some examples:

Supply chain

For a supply chain to work it requires complex logistic solutions and a lot of trust between all the people involved in the process. It’s an extremely complex sphere that drowns in paperwork and bureaucracy.

But with smart contracts you can significantly improve monitoring and tracking of your products as well as remove bureaucracy and bribes which inevitably come with the human factor.

Feel free to read more about this use case on example of Maersk in my post here.

Insurance

Insurance as a business domain also can greatly benefit from implementing smart contracts. They would improve user experience, reduce cost and increase speed of investigations.

Insurance cases can take lots of time for checking and approving all the paperwork. With insurance, as with any other bureaucratic procedure, smart contracts are perfectly fit to streamline and automate the processes.

Mortgages

Applying and getting a mortgage loan shouldn’t take long. The whole process can and should be more transparent and easy to understand both for the loan receiver and for the banks.

In my opinion, all the parties would benefit from clear objective rules specified in the smart contract conditions. So you knew what you need in order to apply and get the loan. And even if you don’t get it on first try, you could clearly see what you need to do to get it next time.

Trade finance

Trade finance is a 10 trillion dollar industry that could save billions with smart contracts. At the moment, this niche still has a lot of space for human error and fraud, which could and should be eliminated with automation.

ICOs

Last but not least, ICO is the primary use case for smart contracts right now. Each token sale is powered by custom or ready-made made contracts like that of Ethereum.

Smart contracts have the potential to significantly improve processes in high-profile industries like supply chain, insurance and trading.

So are smart contracts the silver bullet?

Even though, smart contracts are rather safe right now, there have been quite a few hacks that cost millions of dollars. So if you decide to implement this tech into your project, make sure that it’s very thoroughly tested and developed by someone with relevant experience. Some companies also announce a bounty for anyone who finds critical bugs in a system which seems to be a rather effective technique.

With all the praise blockchain and smart contracts are getting, it’s easy to start thinking that they can solve any problem for any kind of system. Which just isn’t the case. Each project requires in-depth analysis and evaluation of pros and cons of smart contracts implementation. And only if experienced specialists vouch that this tech will help your business, you should look into making it happen.

But still, smart contracts are a great solution to implement in the environments where parties lack trust and want to remove an intermediary from their relations. In addition to that, there are quite a few processes smart contracts automate making the lives of end users easier and the complex systems more transparent.