Smart contracts are receiving significant attention from businesses across a broad range of industry sectors – and for good reasons. But what are smart contracts and why is it imperative that businesses understand what a smart contract is?
Smart contracts are computing programs that automatically self-execute the terms of a contract following the fulfilment of certain conditions. These forms of contracts represent a digital evolution in traditional legal contracts. Whereas a traditional legal contract defines the rules around an agreement between parties, smart contracts go a step further and actually enforce those rules by controlling the transfer of currency or assets under specific conditions. With a smart contract approach – an asset or currency is transferred into a program and the program in turn runs this code. At some point it automatically validates a condition and automatically determines whether the asset should go to one person or back to the other, or whether it should be immediately refunded to the person who sent it, or some combination thereof.
Smart contracts offer a new paradigm, wherein legally binding agreements can be built to run within a network of computers which no single party can pull the plug on. With a smart contract all the parties to the agreement participate in the management and supervision of the computers which have automated the agreement.
Smart contracts are considered ‘smart’ as they are machine readable and executable, and they interact with various internet of things systems simultaneously. A smart contract mirrors a traditional legal contract in that obligations are set out and there are breaches for non-conformance. Smart contracts mean that instead of being able to simply complete a transaction on the blockchain, users can define rules around when and how the transaction would take place. This can be done by setting a certain time frame or requiring multiple signatures in order for the transaction to go through. The agreement is then implemented by a computer – given the conditions of the contract, and a set of defined inputs, the smart contract enforces its own terms.
The benefits associated with smart contracts are that they are written and coded in a way that no single party can stop a smart contract’s operation as no single party controls its operation. As a result of this smart contracts have now become synonymous with blockchain technology and they are bridging the gap between existing legal and commercial arrangements. Legal compliance can be built into the program logic, providing a way of transacting that maximises operational efficiencies with the potential to reduce regulatory cost and risk.
In today’s technologically advanced world, along with the advent of blockchain technology, smart contracts are now increasing in popularity with banks and financial ledger platforms, as well as with users of cryptocurrencies such as Bitcoin. A distinctive feature of a smart contract is its ability to minimise risk through ‘non-discriminatory execution’. This feature means that contracts are executed and performed automatically so long as it fulfils the full criteria of the transaction. Smart contracting technology furthermore has the potential to significantly reduce institution’s infrastructure costs attributable to cross-border payments, securities trading and regulatory compliance.
By building business logic in smart contracts, developers and lawyers can give their users and clients an increase in the verifiability and certainty which comes with distributed technology, while simultaneously building a system of rules which will be structured so that it can keep up with the increases in automation in today’s modern world.