Smart Contracts

Computer codes that digitally facilitate the execution of parts of all of the agreements or contracts kept in public databases

What are Smart Contracts?

Smart contracts refer to computer codes that digitally facilitate the verification, control, or execution of parts of all of the agreements or contracts. Smart contracts run on the blockchain platform, which processes all the transactions in the contracts; hence, third parties are not required for executing the transactions.

 

Smart Contracts

 

Similar to traditional contracts, smart contracts define rules and penalizations related to agreements. Additionally, smart contracts automatically impose such duties and responsibilities. While they can work independently, many smart contracts can also be implemented together.

The integral components of a smart contract are termed as objects. There are essentially three objects in smart contracts – the signatories who are the parties involved in the smart contracts that use digital signatures to approve or disapprove the contractual terms, the subject of agreement or contract, and the specific terms.

 

Summary

  • Smart contracts refer to computer codes that digitally facilitate the execution of parts of all of the agreements or contracts, which are kept in public databases.
  • They are a faster, cheaper, and more secure way of executing and managing agreements.
  • The technical difficulty of making changes and the inability to handle unclear transactions are some issues with smart contracts that need to be rectified to gain mass adoption.

 

Uses of Smart Contracts

Smart contracts can be used in a variety of fields, from healthcare to supply chain to financial services. Some examples are as follows:

 

1. 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 mainly low due to the system that requires voters to line up, show identity, and complete forms. Voting, when transferred online using smart contracts, can increase the turnover rate of millennial voters.

 

2. Healthcare

Blockchain can store the encoded health records of patients with a private key. Only specific individuals are granted access to the records. 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 regulation compliance.

 

3. Supply chain

Many times, supply chains suffer due to paper-based systems where forms pass through multiple channels to get approvals. The 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 tasks.

 

4. 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

 

1. 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 intermediary in smart contracts results in the parties saving money.

 

2. Backup

All the documents stored on blockchain are duplicated multiple times; thus, originals can be restored in the event of any data loss.

 

3. Safety

Smart contracts are encrypted, and cryptography keeps all the documents safe from infiltration.

 

4. Speed

Smart contracts automate tasks by using computer codes, saving hours of various business processes.

 

5. Accuracy

Using smart contracts results in the elimination of errors that occur due to manual filling of numerous forms.

 

Limitations of Smart Contracts

 

1. Difficult to change

Since changing the smart contracts is almost impossible, any error in the code can be time-consuming and expensive to make corrections once the smart contract is employed for execution.

 

2. Possibility of loopholes

According to the concept of good faith, parties will deal fairly and not get benefits unethically from the contract. However, using smart contracts make it difficult to make sure that the terms are met according to what was implied.

 

3. Third party

Although smart contracts seek to eliminate third-party involvement, it is not possible to eliminate them. Third parties take up roles different from the ones they take in traditional contracts. For example, lawyers will not be needed to make a smart contract; however, they will be needed by developers to understand the terms to create codes for smart contracts.

 

4. Vague terms

Since contracts are made of terms that are not always in black and white, smart contracts are unable to handle terms and conditions that are vague.

 

More Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Digital Option
  • FinTech (Financial Technology)
  • Distributed Ledger Technology
  • Machine Learning (in Finance)

M&A Modeling Course

Learn how to model mergers and acquisitions in CFI’s M&A Modeling Course!

Build an M&A model from scratch the easy way with step-by-step instruction.

This course will teach you how to model synergies, accretion/dilution, pro forma metrics and a complete M&A model. View the course now!