Smart contracts are one of the most significant tools in the world of blockchain technology, with the potential to revolutionise industries from finance to real estate. They are self-executing contracts where the terms of the transaction are spelled out in software code, eliminating the need for intermediaries and making processes more transparent, faster and safer. In this article, we take a closer look at how smart contracts work, their benefits, real-world use cases and potential for businesses.
1. What are smart contracts?
A smart contract is a program that automatically performs or cancels actions based on predetermined conditions recorded on the blockchain. It is entered into between two or more parties and the conditions of execution are verified based on information from the blockchain or external sources (oracles).
(a) Autonomy and decentralisation
One of the key advantages of smart contracts is that they are executed automatically, without the need for trust or intervention of third parties such as notaries, lawyers or banks. All data is stored decentralised on a blockchain, making the system resistant to manipulation and fraud.
(b) Transparency and immutability
Like all transactions on the blockchain, smart contracts are completely transparent and immutable. Once a contract is made and recorded on the blockchain, it cannot be changed, thus eliminating the possibility of breach of contract.
2. How smart contracts work
The basic principle of how smart contracts work is based on the fulfilment of “if-then” conditions. For example, if one party sends funds to a certain address, the system automatically fulfils the next part of the contract – sending goods or services.
(a) Programme code and blockchain
A smart contract is a programme code that is written on the blockchain. This code spells out all the conditions and actions that will be performed when certain events occur. Once all the conditions are fulfilled, the smart contract is activated and performs the required actions.
(b) Oracles and external data
For some smart contracts, it is necessary to obtain data from the external world. In such cases, oracles are used, which are special services that feed data from external sources (e.g. weather conditions, exchange rates) into the blockchain.
3. Business benefits of smart contracts
The use of smart contracts can significantly improve business processes by automating, reducing transaction costs and eliminating middlemen.
a) Saving time and money
Smart contracts eliminate multiple intermediaries, which reduces legal costs, commissions and transaction time. All processes are automated, making transactions faster and cheaper.
(b) Safety and security
Since smart contracts are blockchain-based, all data is encrypted and protected from unauthorised access. This reduces the risk of fraud and protects against data loss.
(c) Automation and scalability
Companies can use smart contracts to automate various processes from supply chain management to customer settlement. This scales the business and improves its efficiency.
4. Real-world examples of smart contracts
Smart contracts have already found use in a variety of industries, and their use continues to expand.
(a) Financial Services
In banking, smart contracts are used to automate loan agreements, dividend payments and insurance policies. For example, a smart contract can automatically pay an insurance amount to a customer when an insured event occurs.
(b) Real estate
In the real estate sector, smart contracts enable secure purchase and sale transactions without the involvement of notaries and realtors. As soon as all the conditions of the transaction are fulfilled, the property rights are automatically transferred to the buyer and the funds to the seller.
(c) Logistics and supply chain management
Smart contracts allow goods to be tracked throughout the supply chain. Everyone involved in the transaction can see the current status of the goods, and payments are automatically processed when certain milestones are reached.
5. Potential challenges and limitations of smart contracts
Despite the many advantages, smart contracts face a number of challenges that need to be considered.
(a) Legal uncertainty
Many countries have not yet developed legislation to regulate smart contracts. This can create difficulties in resolving disputes or recognising such contracts in the courts.
(b) Errors in code
As smart contracts are software code, errors in the code can lead to failures or loss of funds. Quality testing and auditing of smart contracts is essential to ensure their security.
(c) Dependence on oracles
When external data needs to be used to execute smart contracts, there is a dependency on the accuracy and reliability of oracles. If an oracle provides erroneous information, it may lead to improper contract fulfilment.
6. Future of smart contracts
Smart contracts have a huge potential for further development. With the increasing adoption of blockchain and improved legal frameworks, they are expected to become a standard business tool.
(a) Mass adoption in various industries
Smart contracts could become an integral part of finance, logistics, insurance and other industries in the coming years. Companies that are able to adopt this technology will gain a competitive advantage.
(b) Technology development
Smart contracts will improve with the development of blockchain technology and security systems. More sophisticated and feature-rich contracts will emerge that can manage more complex processes and interact with other blockchains.
Conclusion
Smart contracts are a powerful tool that are already starting to change the rules of the game in business. Through automation, security and transparency, they can make processes more efficient and reduce costs. However, for their widespread adoption, a number of challenges need to be addressed, such as legislative regulation and addressing technical risks.