Smart Contracts

Computer protocols that digitally facilitate the verification, control, or execution of an agreement

Written by CFI Team

What are Smart Contracts?

Smart contracts refer to computer protocols that digitally facilitate the verification, control, or execution of an agreement. Smart contracts run on the blockchain platform, which will process all the transactions in a contract; hence, middlemen are not required to execute the transactions.

Smart Contracts

Similar to traditional contracts, smart contracts define rules and penalties around an agreement and automatically enforce those obligations. While they can work independently, many smart contracts can also be implemented together.

The integral components of a smart contract are termed objects. There are essentially three objects in a smart contract – 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 the agreement or contract; and the specific terms.

Summary

Smart contracts refer to computer protocols that digitally facilitate the execution of an agreement, 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 complex 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 historically low due to the inefficient system that requires voters to line up, show identity, and complete forms. Voting, when transferred online using smart contracts, can increase the number of participants in a voting system.

2. Healthcare

Blockchain can store the encoded health records of patients with a private key. Only specific individuals would be granted access to the records for privacy concerns. 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

Traditionally, supply chains suffer due to paper-based systems where forms pass through multiple channels to get approvals. The laborious 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 transform 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 an intermediary in smart contracts results in cost savings.

2. Backup

All the documents stored on the 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 protocols, saving hours for various business processes.

5. Accuracy

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

Limitations of Smart Contracts

1. Difficult to change

Changing smart contract processes is almost impossible; any error in the code can be time-consuming and expensive to correct.

2. Possibility of loopholes

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

3. Third party

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

4. Vague terms

Since contracts include terms that are not always understood, smart contracts are not always able to handle terms and conditions that are vague.

More Resources

CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA®) 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: