What are Smart Contracts: Blockchain-based contracts

For so many years, the process of companies and individuals engaging with other parties to buy a house, agree on insurance policies, sign a sales contract, etc. have been complex. 

The lack of trust and transparency made parties more cautious and have to spend significant time and money on intermediaries such as financial institutions to finalize these agreements. 

For this reason, the arrival of smart contracts has been revolutionary, removing third-party involvement and allowing more transparency and security for both parties because it uses blockchain technology. 

This article is going to cover the definition of smart contracts, how it works, the common applications of smart contracts in the real world and their importance.

What is a Smart Contract? Definition

Is an agreement between two parties where the terms and conditions are on a decentralized network such as a blockchain. 

It has its own autonomy because it enforces and executes itself automatically based on a series of programmed parameters. The way it works without the need of third parties or intermediaries. No lawyers or notaries are needed like traditional contracts do. Once the agreement is executed, it is reflected in a code or script. Decreases human error and allowing automated tasks without requiring human interaction. 

These contracts have been previously established on the blockchain networks,  so there is an active execution. In other words, there is no possibility to make any changes in the guidelines or contract terms. 

Although its programming language can vary depending on the network and blockchain platforms where it is located, the function and characteristics of smart contracts stay the same.

Something that must be noted is that even though smart contracts have a legally binding contractual effect, being deployed in technology like blockchain, makes it difficult in terms of legal enforceability. This is because it may lack a central administering authority to determine a dispute or even have a clear idea of who the defendant is. This is something you may have in mind. 

How do Smart Contracts work?

To have more in-depth knowledge about smart contracts, it is vital to know how its process works. Therefore, we are going to segment the process into various steps, which are the following: 

Step 1: The criteria are defined by the developers and business teams. The execution of smart contracts follows a defined pattern in response to particular circumstances or events. At this stage, there are considered elements such as payment authorization conditions, when to release an insurance payment, shipment receipt, etc.  

Step 2: The smart contract has to pass a set of tests and security checks. Then, it is deployed to an existing blockchain technology like Ethereum once it has received an authorization. 

Step 3: All the terms of the contract are visible to all the parties involved in the blockchain. This way they can initiate the negotiation of the terms of the contract. 

Step 4: When the terms of the contract are fully set,  and the smart contract obtains the necessary combination of parameters from one or more oracles which are cryptographically secure streaming data sources, the contract is executed automatically. 

Step 5: At this stage, the smart contract is now immutable and it is not possible to be changed by any of the parties involved. 

Step 6: The transfer of assets previously agreed upon happens. For instance, the transfer of information, stock, insurance, real estate, etc.

Examples of Smart Contracts applications

The possibilities are endless when it comes to smart contracts. However, some applications of smart contracts that are commonly used in the real world are the following:

  • Encoding financial agreements: Smart contracts allow the management of agreements between users. For example, if a user buys insurance from a company, the directives could program it by a smart contract.
  • Manage multi-signature accounts: It’s challenging when there are multiple people in the agreement. Smart contracts allow to determine a required percentage of people that need to agree when it comes to spending funds. 
  • Storage and maintenance of records: It could be used to store and update in a secured manner millions of confidential records and information. Storage in a blockchain means that the data becomes immutable and it is not possible to erase it. 
  • Speed up the trading process: Approval of funding is needed in most commercial activities. For this reason, using smart contracts can be more efficient in terms of time and process of execution. 
  • Make supply chains more effective: Errors and loss can be avoided with smart contracts. They can be used to record every step of a product in the supply chain and improve its traceability. 
  • Insurance accuracy: The insurance industry has to deal with a large amount of claims every year. This makes the work tedious and long. For this reason, smart contracts are used to approve payments to be released automatically following the policy guideline agreeded.  

Why are smart contracts important?

The future of smart contracts is promising and they are here to stay. They are still considered an emerging technology. However, all types of major industries are increasing their efficiency because of it. From financial services to healthcare services, insurance services, banking, public management, and the energetic industry. Even the gaming industry as smart contracts allow the creation of efficient gaming products. 

Also allows crypto holders to engage in complex financial transactions. They can involve insurance, loans, or savings without third parties having to be involved such as financial institutions like banks. This makes the transaction more profitable for businesses and customers as there are no commissions or banks taking a cut.

The security involving smart contracts decrease the probability of failure or the vulnerability of being involved in virtual attacks or hacks. Additionally, considering that all parties have full access to these smart contracts, it will protect them from any fraudulent activity in case of a dispute

As the technology matures, it is expected that more organizations, individuals, and crypto traders take advantage of this resource. Also, the popularity of smart contracts keeps growing because of the benefits it offers. Some of them would be transparency, speed, trust, and security. For this reason, those who decide to incorporate them into their operations will get a first-mover advantage. Something important in a high-paced and competitive world.