And so, let’s start by remembering what is called a smart contract.
According to the description given on Coinmarketrate.com, a smart contract is based on computer protocols. Thus, it is a kind of digital contract based on blockchain technology. The terms of the agreement between the “buyer” and the “seller” are written directly in the lines of code.
Smart contracts are self—executing contracts, which means that they take effect independently upon the occurrence of certain predetermined events and therefore do not require human control. If these entry conditions are met, the algorithm automatically initiates a transaction, which is then confirmed and stored in the block. Thus, smart contracts allow for reliable transactions and agreements between different parties. These digital contracts are quite comparable to classical contracts, for example, a purchase and sale agreement or an insurance policy. Since such a smart contract is processed without human intervention, typical sources of errors can also be eliminated.
Probably the most famous blockchain platform for developing such digital contracts is Ethereum. But in the case of Tezos, there is already a second blockchain that provides extensive functions. Programming of such a contract can be performed using Solidity, a specialized programming language for Ethereum.
Are smart contracts legally binding
A contract is an agreement between several parties. Accordingly, the contract always contains legally binding statements of intent of the contracting parties.
In principle, contracts can be concluded in writing, orally or conclusely. Due to legal certainty, the Contracting Parties usually choose a written form. Therefore, such a contract should always contain general terms in addition to the direct name of the contracting parties.
The smart contract also follows this principle and contains the relevant contract information. However, this information is already defined in the program code during development. Therefore, the following applies to smart contracts: the code is the law. Simply put, such a contract is an “if —then” rule that contains all the information necessary to conclude a contract.
How smart contracts technically work
Simply put, a smart contract is a small program that runs on the blockchain and executes simple “if—then” rules. Developers define conditions and actions in advance, which are then performed automatically.
Here, smart contracts take advantage of the blockchain and are transparent, irreversible and traceable. Since these small programs are based on blockchain, no intermediary can influence their execution. Instead, all transactions take place on the blockchain. This reduces costs. Due to decentralization, smart contracts function independently and do not have time delays.
Within the framework of a distributed ledger, these digital contracts are treated as a separate account with a public address, while this account does not actually exist, and therefore no one has a private key. After creation, access from outside is excluded. The content of the contract must be defined in the form of actions and conditions so that the account can fulfill them automatically. This way it can connect and interact with other accounts.
What are the special advantages?
In comparison with classical forms of contracts, smart contracts have a number of advantages. These include:
Smart contracts are based on blockchain technology and are therefore protected by cryptographic encryption methods. Accordingly, no one can subsequently change the agreed terms of the contract.
Programming a smart contract takes very little time, and subsequent processing is automated. Classical forms of contracts are more voluminous both in terms of creation and processing, so time and cost savings are achieved through automation.
Properly programmed smart contracts almost completely eliminate gaps in the interpretation of contract terms. In addition, all documents are documented on the blockchain, so their loss is impossible.
Thanks to the decentralized organization of the smart contract, there is no need for third-party organizations such as banks or notaries. Instead, the blockchain takes over the verification of the transaction. The principle “the code is the law” applies – the validity of the contract depends solely on the fulfillment of the terms of the contract.
What are the disadvantages of smart contracts?
Even if the advantages of these digital contracts are convincing at first glance, their concept has not yet been fully developed. Consequently, errors are also possible when using programs. Due to the features of the blockchain, transactions that have already been executed are irrevocably documented in the blockchain. Consequently, a subsequent correction is no longer possible.
For example, a mistake in a decentralized autonomous organization (DAO) allowed US$ 50 million to be stolen on June 17, 2016. Due to an underlying error, the developers of the Ethereum blockchain were forced to upgrade, which led to a hard fork of the actual blockchain. The direct result was the Ethereum Classic cryptocurrency, which was based on a forked blockchain.
In addition, it is possible that developers introduce backdoors into the program code. This circumstance indicates not only that blockchain matters, but also that reliable developers are needed. Finally, a valid internet connection is required to execute a smart contract. Currently, this requirement cannot be met worldwide, so global use of the technology is not possible.
What can smart contracts be used for?
The options for using blockchain-based contracts are almost limitless. For this reason, we would like to focus on a narrower selection of possible use cases.
Digital contracts can define and regulate lease terms. The smart contract can automatically lower or increase the rent, depending on the market value of the property or the agreement in the lease agreement. It is also possible that they can change the way real estate is bought and sold forever.
- Insurance companies
Using smart contracts, insurance companies can process claims automatically, and thereby reduce costs in the long run. In addition, the relevant information about the insured event can be transparently and irreversibly documented in the blockchain. In the context of travel insurance, a smart contract can, for example, track flight data and transfer the appropriate compensation directly in the event of a flight delay.
- Supply chains
Modern supply chains are multilevel and include several counterparties. In addition to the manufacturer and its suppliers, the supply chain also includes intermediaries, manufacturers and consumers. With the help of digital contracts, the contracting parties can cooperate on a common basis. In addition, the blockchain allows you to transparently track the product.
Another possibility of using smart contracts is software licensing. Using them, software developers can specify in the contract that the program will be automatically blocked in case of unauthorized access.
How are smart contracts programmed?
Smart contracts can be programmed using the contract-oriented Solidity programming language. This programming language can be used with various blockchains. When Solidity was introduced, the programming language only worked on the Ethereum blockchain. Meanwhile, developers can use this programming language to create intelligent programs for various DLTs.
For programming, developers only need a browser. For the subsequent compilation of the code, an appropriate client is required. Basically, the Solidity syntax is similar to ECMAScript. In addition, it is a deterministic language that excludes random events. After the actual program is executed, the transaction is verified using network nodes.
It is not surprising that smart contracts are considered one of the most important functions of the blockchain. With these small programs, contracts can be fully automated. In addition, these programs provide a high degree of legal security, so that attacks are practically impossible.
From the point of view of companies, these functions are very interesting. In particular, insurance companies, financial service providers or utilities can benefit from the use of technology. However, at the moment there are still few examples illustrating successful use.