Smart contracts are lines of code stored in a blockchain and executed automatically as per the specified conditions. Blockchain technology makes it possible to conduct transactions and agreements between anonymous parties without the need for a central entity, external application, or legal system.
Blockchain technology stores transactional records, also known as the ‘block,’ of the public in several databases, known as the ‘chain,’ in a network connected through system-to-system nodes. This storage is typically known as a ‘digital ledger.’
In a smart contract, the data is encrypted and remains in the general ledger. This encryption means that information stored in blocks can never be lost, changed, or deleted.
Working Principle of Smart Contracts
6 Basic Steps for Smart Contracts:
Key Benefits of Smart Contracts
Smart contracts provide various advantages over traditional contracts for a wide range of industries.
- More efficiency and speed: Smart contracts can improve the efficiency and speed with which businesses make deals. Smart contracts are automated, and people do not have to spend a lot of time on paperwork and manually fixing errors.
- Precision and transparency: Since the coded words are apparent and accessible to all parties involved, there is no possibility of a challenge after the smart contract conclusion. This function complements the transaction’s transparency and can eliminate the possibility of forgery, distortion, or errors. This system, in turn, reduces monitoring costs and the risk of opportunistic behavior.
- Trust: Smart contracts can increase the level of trust in parties. They conduct transactions automatically according to established laws, and the participants receive transactions’ encrypted documents. Information about the contract and the terms of the agreement is straightforward. Specific verification and work by each guarantee that the smart contract is unbreakable.
- Security: The smart contracts provide better protection, as all actions are recorded and verified. Blockchain transaction documents are encrypted, which makes them extremely difficult to hack. Security features can be built into smart contracts to automatically backup and duplicate in the event of damage, loss of original contract data, or hacking.
- Absence of Physical Need: An electronic signature concludes a smart contract, eliminating the need for the parties’ physical presence – a disadvantage that traditional agreements do not have the potential to avoid.
Key Challenges Faced in Smart Contracts
- Human failure: Like paper contracts, smart contracts can also be subject to fraud due to human error. Smart contracts are codes written by people (coders). Therefore, a high probability of errors in the smart contract code is possible.
- Privacy and Data Security: Unlike traditional contracts, all transactions performed through a smart contract are spread across all network nodes, creating privacy concerns, especially if the parties’ accounts link to known companies. Even though the parties rely on pseudonyms, some identification techniques can identify parties dealing with a particular smart contract.
- Lack of Technical Experience: As smart contracts become mainstream, new types of cryptographers and forensic professionals will need to examine software codes and translate them into human-readable forms. Expert engineers are required for a smart contract to work flawlessly. However, it is costly and challenging to find skilled programmers.
- Legal and regulatory challenges: There are also many legal and regulatory challenges to prevent smart contracts’ widespread use. Smart contracts do not have an exact legal status. There are no official government regulations that apply to them.
Key Application and Use Cases
A smart contract is used for various applications in different industries to enable an intelligent process:
Smart Contracts for Digital Identity
Smart contracts allow individuals to control their digital identity, including reputation, data, and digital assets. It will enable individuals to choose personal data to share with counterparties and allow businesses to understand their customers better.
Challenges faced in ordinary contract systems
- Incompletely expensive and time-consuming KYC procedures.
- Limited control over potential data leaks due to an individual’s trust in trusted third parties.
- High responsibility for protecting user data is a source of error and a target for hackers.
Smart contracts are helping to meet challenges
- Own control of personal data where people can share personal data with various counterparts securely.
- Counterparties are not required to store sensitive data to verify transactions with increased compliance, flexibility, and interoperability.
For instance, Ericsson, a leading provider of Information and Communication Technology (ICT) solutions, provides smart contract-based identity management solutions implemented and tested in Calvin for secure communication between Calvin runtimes via TLS.
Smart Contracts for Securities
Simplifying the administration of capitalization tables and bypassing the mediators in the securities administration chain is done by implementing a smart contract. Smart contracts can facilitate automatic dividend payments, stock splits, and liability management while minimizing counterparty and operational risks.
Challenges faced in ordinary contract systems
- Paper-based and manual corporate registration processes have shortcomings.
- Companies failing to keep their corporate registrations up to date require a clean-up and good standing certificate before issuing securities.
- Mediators increase cost, counterparty risk, and latency.
Smart contracts are helping to meet challenges
- End-to-end digitized workflows contain titles that exist in a distributed ledger.
- Facilitated automatic payment of dividends and stock splits, enabling more accurate proxy voting
- Eliminated counterparty and operational risks caused by middlemen
For instance, Quantstamp is a blockchain security company that has built a decentralized automated smart contract security analyzer network deployed worldwide.
For Instance, Public chain projects Nervos and Cardano have jointly launched a research initiative to enhance smart contracts’ security by improving Unspent Transaction Outputs (UTXOs).
Commercial Activities: Smart Contracts
- In November 2019, Applicator, a blockchain development agency, announced the partnership with GATE TO BALTICS, an international law firm in Estonia, to ensure legal support and licensing process guidance for blockchain projects.
- In December 2020, Wolfram Alpha, a computational knowledge engine providing technology for significant services, teams up with Cardano to build ‘avant-garde oracles.’ The new partnership will specifically address work on the so-called “avant-garde oracles,” which the companies believe are essential to building advanced smart contracts.
