Smart contracts can be termed as a self-executing contract bearing the terms of agreement between the seller and the buyer and are being directly written into the lines of codes. The code and the agreements that are contained therein exists across a decentralized and distributed blockchain network. The controls the execution and the transactions get traceable and irreversible.
The smart contracts permit the trusted transactions and the agreements to be carried out among the anonymous and disparate parties without the requirement for a central authority, external enforcement mechanism or legal system. While the Blockchain technology has been primarily thought of as the foundation for the Bitcoin, it has developed far beyond underpinning the virtual currency or the digital currency.
The top 10 smart contracts or project includes:
- Ethereum (ETH)
- Cardano (ADA)
- Solana (SOL)
- Polkadot (DOT)
- Terra (LUNA)
- Avalanche (AVAX)
- Algorand (ALGO)
- Cosmos (ATOM)
- Internet Computer (ICP)
- VeChain (VET)
The Backstory In A Gist
The term “Smart Contracts” were first proposed by an American computer scientist named Nick Szabo in 1994. He had invented a digital currency named “Bit Gold” in the year 1988, 10 years before the invention of Bitcoin. Informations state that he is often rumored to be the original Satoshi Nakamoto, the anonymous inventor of Bitcoin (BTC). Unfortunately, Szabo has denied the claims.
He has defined smart contracts as the computerized transaction protocols executing the terms of a contract. He had always wanted to extend the functionality of the electronic transaction methods like the point of sale or PoS to the digital realm.
Szabo has also proposed the execution of a contract for the synthetic assets like derivatives and bonds in his paper. He wrote,
“These new securities are formed by combining securities (such as bonds) and derivatives (options and futures) in a wide variety of ways. Very complex term structures for payments can now be built into standardized contracts and traded with low transaction costs, due to computerized analysis of these complex term structures.”
Szabo had stated a couple of predictions in his paper and many of them came true in ways preceding the blockchain technology. For instance, the derivatives trading is currently mostly conducted via the computer networks utilizing the complex term structures.
How Do Smart Contracts Work?
The smart contracts function by following the simple “if/when….then….” statements that are written into the code on a blockchain. A network of computers executes the actions when the predetermined conditions are met accordingly and verified. These actions could include anything from releasing the funds to the appropriate parties, sending notifications, registering a vehicle or even issuing a ticket. Then the blockchain is updated when the transaction gets completed. This means that the transactions cannot be altered and the only parties who possess the permission can also see the results.
There can be as many stipulations as required to satisfy the participants that the task will get completed with satisfaction within a smart contract. For establishing the terms, the participants are required to determine how the transactions and the data are represented on the blockchain, agree on the “if/when….then….” rules that govern those transactions, explore all the possible exceptions and then define a framework for resolving the disputes.
Following this, the smart contract can be programmed by a developer. It is seen that there has been an increase in the organizations that utilize the blockchain for the businesses offering web services, templates and several other online tools for simplifying structuring smart contracts.
What Are The Types Of The Smart Contracts?
There are three basic types of smart contracts viz., the Smart Legal Contract, the Decentralized Autonomous Organizations (DAO) and the Application Logic Contracts (ALC).
Smart Legal Contract
This is the most common type of smart contract involving the similar legal requirements to its traditional counterpart such as mutual assent that is expressed by a valid offer and acceptance, the adequate consideration, legality and capacity. It has been put into place for holding the concerned parties accountable for fulfilling the end of an agreement. When the smart legal contracts are set up properly, a smart contract is legally enforceable and needs the parties to meet their obligations. The failure to fulfil the obligations in the contract might result in the legal action that can be triggered automatically via the smart contract against the party in breach.
Decentralized Autonomous Organizations (DAO)
DAO can be referred to as the communities that exist on the blockchain. These communities can be defined as a set of agreed upon rules coded via the smart contracts. All the participants and their actions are subjected to the rules of the community with the task of enforcing these rules and regulations. All of these rules are made up of several smart contracts and they work together to watch over the other community activities.
Application Logic Contracts (ALC)
The ALCs contain an application-based code that remains in connection with the other blockchain contracts. They enable the communication across the various devices like the merging of an Internet of Things or IoT with the blockchain technology. ALCs are a major piece of the multi-function smart contract and primarily works under a managing program.
What Are The Benefits Of Smart Contracts?
There are several benefits of smart contracts. Below are all the benefits described in detail.
Accuracy, Efficiency & Speed
As soon as the conditions are met, the contract is executed on an immediate basis. This is owing to the fact that the smart contracts are automated and digital, there requires no paperworks to process and time is not wasted in reconciling the errors that often result from the manual filling in of the documents.
Transparency & Trust
As there is no third party involved and no encrypted records of the transactions are shared across the participants, there is no requirement to question if the information has been modified for personal benefit.
The records of the blockchain transactions are encrypted and this is what makes them very difficult to hack. Furthermore, owing to the fact that each of the records are connected to the previous and the subsequent records on the distributed ledger, the hackers would have to alter the complete chain for changing a single record.
The blockchain smart contracts eliminate the requirement for the intermediaries to handle the transactions and by extension, their fees, associated time and delays.
What Are The Limitations Of Smart Contracts?
With the benefits, smart contracts in blockchain bring in some of the major disadvantages or limitations that have been discussed below.
Difficulty To Change
Changing the smart contract processes is nearly impossible. Any error in the code might be time consuming and at the same time it might be a lot expensive for rectification.
Chances Of Loopholes
As per the concept of the good faith, the parties will fairly deal and not get any benefits unethically from a contract. However, utilizing the smart contracts makes it pretty complex to ensure that the terms are fulfilled according to what had been agreed upon.
Despite the fact that these contracts seek to discard the third party involvement, it is not possible in reality to eliminate them completely. The third parties take up various roles from the ones that they take in the traditional contracts. Nevertheless, they will be required by the developers to understand the terms and create codes for the smart contracts.
As these contracts consist of the terms that are not always completely understood, the smart contracts are not always able to manage the terms and conditions that are obscure or obsolete.
What Are The Smart Contracts Used For?
These contracts on the blockchain can have use cases in multiple fields from supply chain, to health care and to the financial sectors. Below are some of the examples of smart contracts and its applications in various sectors.
The smart contracts aid in transforming the financial service in a plethora of ways. In an instance of the insurance claims, the smart contract is responsible for performing the error checking, routing and transfer payments to the user in case everything is found appropriate.
These contracts include some of the critical tools for bookkeeping as well as eliminates the chances of infiltration of the accounting records. They are also responsible for enabling the shareholders to take part in the decision making in a pretty transparent way. Additionally, they also aid in trade clearing where the funds get transferred as soon as the amounts of the trade settlements are calculated.
Government Voting System
The smart contracts offer a secure environment and makes the voting system less susceptible to manipulation. All the votes that use the smart contracts would be protected in the ledger and that makes it extremely difficult to decode. Furthermore, the smart contracts might increase the turnover of the voters that is historically low owing to the inefficient system that seeks the voters to line up, show their identity and complete the forms. When voting is transferred online using the smart contracts, it can thereby increase the number of the participants in a voting system.
Blockchain is capable of storing the encoded health records of the patients with the help of a private key. Only a group of individuals are granted access to the records for privacy concerns. Likewise, research can also be conducted confidentially and securely utilizing the smart contracts. All the hospital and nursing home receipts of the patients can be efficiently stored on the blockchain and then automatically shared with the insurance companies as a proof of service. Additionally, the ledger can also be used for various other activities like supervising drugs, managing the supplies and regulation compliance.
Customarily, the supply chain suffers owing to the paper based systems where the forms pass via the multiple channels for receiving the approvals. The laborious process then expands the risk of fraud and loss. Additionally, blockchain can also nullify such dangers through delivering an accessible and secure digital version to the parties that are involved in the chain. The smart contract also finds its application in the inventory management and the automation of the tasks and payments.
With this, the smart contract is often confused with the smart legal contracts where both of them differ vastly from each other. As already stated before, smart contracts are not necessarily legally enforceable as a contract. On the contrary, a smart legal contract bears all the elements of a legally enforceable contract in the jurisdiction where it can be enforced by a tribunal or a court. As a result, while all smart legal contracts will include some elements of a smart contract, not every smart contract will be a smart legal contract.