A smart contract is a self-executing contract with the terms of the agreement between buyer and seller being directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network. The code controls the execution, and transactions are trackable and irreversible. Smart contracts permit trusted transactions and agreements to be carried out among disparate, anonymous parties without the need for a central authority, legal system, or external enforcement mechanism. Smart contracts are self-executing contracts with the terms of the agreement between buyer and seller being directly written into lines of code. For this reason, we have an interview with Alireza Mehrabi, an entrepreneur and cryptocurrency analyst, to find out his opinion on the smart contract.
How Smart Contracts Work?
Smart contracts work by following simple “if/when…then…” statements that are written into code on a blockchain. A network of computers executes the actions when predetermined conditions have been met and verified. These actions could include releasing funds to the appropriate parties, registering a vehicle, sending notifications, or issuing a ticket. The blockchain is then updated when the transaction is completed. That means the transaction cannot be changed, and only parties who have been granted permission can see the results.
Within a smart contract, there can be as many stipulations as needed to satisfy the participants that the task will be completed satisfactorily. To establish the terms, participants must determine how transactions and their data are represented on the blockchain, agree on the “if/when…then…” rules that govern those transactions, explore all possible exceptions, and define a framework for resolving disputes. Then the smart contract can be programmed by a developer – although increasingly, organizations that use blockchain for business provide templates, web interfaces, and other online tools to simplify structuring smart contracts.
Benefits of smart contracts
- Speed, efficiency, and accuracy
Once a condition is met, the contract is executed immediately. Because smart contracts are digital and automated, there’s no paperwork to process and no time spent reconciling errors that often result from manually filling in documents.
- Trust and transparency
Because there’s no third party involved, and because encrypted records of transactions are shared across participants, there’s no need to question whether information has been altered for personal benefit.
- Security
Blockchain transaction records are encrypted, which makes them very hard to hack. Moreover, because each record is connected to the previous and subsequent records on a distributed ledger, hackers would have to alter the entire chain to change a single record.
- Savings
Smart contracts remove the need for intermediaries to handle transactions and, by extension, their associated time delays and fees.
Applications of smart contracts
Smart contracts can be used in a variety of fields, from healthcare to supply chain to financial services. Some examples are:
- Government voting system
Smart contracts provide a secure environment making the voting system less susceptible to manipulation. Votes using smart contracts would be ledger-protected, which is extremely difficult to decode. Moreover, smart contracts could increase the turnover of voters, which is historically low due to the inefficient system that requires voters to line up, show identity, and complete forms. Voting, when transferred online using smart contracts, can increase the number of participants in a voting system.
- Healthcare
Blockchain can store the encoded health records of patients with a private key. Only specific individuals would be granted access to the records for privacy concerns. Similarly, research can be conducted confidentially and securely using smart contracts. All hospital receipts of patients can be stored on the blockchain and automatically shared with insurance companies as proof of service. Moreover, the ledger can be used for different activities, such as managing supplies, supervising drugs, and regulating compliance.
- Supply chain
Traditionally, supply chains suffer due to paper-based systems where forms pass through multiple channels to get approvals. The laborious process increases the risk of fraud and loss. Blockchain can nullify such risks by delivering an accessible and secure digital version to parties involved in the chain. Smart contracts can be used for inventory management and the automation of payments and tas
- Financial services
Smart contracts help in transforming traditional financial services in multiple ways. In the case of insurance claims, they perform error checking, routing, and transfer payments to the user if everything is found appropriate. Smart contracts incorporate critical tools for bookkeeping and eliminate the possibility of infiltration of accounting records. They also enable shareholders to take part in decision-making in a transparent way. Also, they help in trade clearing, where the funds are transferred once the amounts of trade settlements are calculated.
Benefits of Smart Contracts
- Autonomy and savings
Smart contracts do not need brokers or other intermediaries to confirm the agreement; thus, they eliminate the risk of manipulation by third parties. Moreover, the absence of intermediaries in smart contracts results in cost savings.
- Backup
All the documents stored on blockchain are duplicated multiple times; thus, originals can be restored in the event of any data loss.
- Safety
Smart contracts are encrypted, and cryptography keeps all the documents safe from infiltration.
- Speed
Smart contracts automate tasks by using computer protocols, saving hours of various business processes.
- Accuracy
Using smart contracts results in the elimination of errors that occur due to the manual filling of numerous forms.
Limitations of Smart Contracts
- Difficult to change
Changing smart contract processes is almost impossible, any error in the code can be time-consuming and expensive to correct.
- Possibility of loopholes
According to the concept of good faith, parties will deal fairly and not get benefits unethically from a contract. However, using smart contracts makes it difficult to ensure that the terms are met according to what was agreed upon.
- Third party
Although smart contracts seek to eliminate third-party involvement, it is not possible to eliminate them. Third parties assume different roles from the ones they take in traditional contracts. For example, lawyers will not be needed to prepare individual contracts; however, they will be needed by developers to understand the terms to create codes for smart contracts.
- Vague terms
Since contracts include terms that are not always understood, smart contracts are not always able to handle terms and conditions that are vague.