What are smart contracts on the blockchain?

Who is this article for?

• Businesses and enterprises looking to streamline transactions and automate processes using blockchain technology
• Developers and programmers interested in learning about smart contract development
• Legal professionals who want to understand the implications of smart contracts on traditional legal services
• Financial institutions exploring applications of blockchain and smart contracts in banking and finance
• Supply chain and logistics companies aiming to improve transparency and efficiency of operations
• IT managers and CIOs tasked with evaluating and implementing emerging technologies

This article is relevant for the above audiences as smart contracts have the potential to disrupt and transform processes across these industries by enabling automated, transparent and secure transactions on the blockchain.

What are smart contracts and how do they work?

At the most basic level, a smart contract is a self-executing agreement with the terms between buyer and seller directly written into lines of code. The code and the agreements contained therein exist across a distributed, decentralized blockchain network (Koulu, 2016).
Smart contracts work similarly to vending machines in the physical world. With a vending machine, you input money and the machine is programmed to dispense your selected item if you meet the required price. If you don’t input enough money, you don’t get the item. The key point is that the vending machine directly controls the assets (the items inside) and automatically executes the transaction based on predefined conditions.

• Autonomy – You’re the one making the agreement; there’s no need to rely on a broker, lawyer or other intermediaries to confirm. Incidentally, this also knocks out the danger of manipulation by a third party (Koulu, 2016).
• Trust – Your documents are encrypted on a shared ledger. There’s no way that someone can say they lost it (Lee, 2019).
• Redundancy – Your documents are duplicated many times over on the blockchain, so they’ll always be accessible (Norta, 2015).
• Safety – Cryptography, the encryption of websites, keeps your documents safe. There is no hacking. In fact, it would take an abnormally smart hacker to crack the code and infiltrate (Zupan et al., 2020).
• Speed – You’d ordinarily have to spend chunks of time and paperwork to manually process documents. Smart contracts use software code to automate tasks, thereby shaving hours off a range of business processes (Ahmadisheykhsarmast & Sönmez, 2020).
• Savings – Smart contracts save you money since they knock out the presence of an intermediary. You would, for instance, have to pay a notary to witness your transaction (Koulu, 2016).
• Accuracy – Automated contracts are not only faster and cheaper but also avoid the errors that come from manually filling out heaps of forms (Koulu, 2016).

Agreement on terms between parties involved in the transaction
Coding the agreed upon terms into a smart contract using programming languages like Solidity
Deploying and storing the smart contract on the blockchain
Execution of the contract when the coded conditions are met
Updating relevant accounts and records based on the contract outcome

The blockchain acts as the underlying infrastructure that enables smart contracts. It provides a tamper-proof, transparent and shared ledger to record transactions. Each smart contract is identified by a unique address on the blockchain. When a transaction occurs, the blockchain is updated and the transaction is recorded as a new block added to the chain.

What are some real-world use cases for smart contracts?

Smart contracts have applications across many industries. Here are some key use cases:

Financial Services

Smart contracts can automate and streamline many financial processes and agreements such as:

• Loan issuance and processing – Smart contracts can automatically release loan funds to the borrower once all required documentation is submitted and verified.
• Trade clearing and settlement – Trades can be verified, cleared and settled almost instantaneously using smart contracts, significantly reducing operational costs and time compared to traditional methods (Giovanni, 2019).
• Insurance claim processing – Claims can be automatically validated and paid out using smart contracts if the required criteria are met, without needing manual review.
• Royalty payments – Smart contracts can automate the distribution of royalty payments to artists, musicians and other content creators when their work is used or purchased (Park et al., 2018).

Supply Chain Management

Smart contracts can bring greater transparency, traceability and efficiency to supply chain operations. Potential applications include:

• Inventory tracking – Smart contracts, combined with IoT sensors, can track inventory levels in real-time and automatically place orders to suppliers when stock is low (Giovanni, 2019).
• Provenance and authenticity – Smart contracts provide an immutable record of an asset’s origin, ownership and journey through the supply chain, helping combat counterfeiting (Baharmand & Comes, 2019).
• Automatic payments – Suppliers can be automatically paid upon delivery of goods using smart contracts, reducing payment delays and disputes (Baharmand & Comes, 2019).

Real Estate

Smart contracts can simplify and speed up many real estate transactions such as:

• Property sales – Smart contracts can automate the transfer of property ownership and release of funds once all sale conditions are met and required documents are submitted.
• Lease agreements – Rental payments can be automatically deducted and transferred to the landlord on a set schedule using smart contracts (Fiorentino & Bartolucci, 2021).
• Fractional ownership – Smart contracts enable the tokenization of real estate assets, allowing them to be easily divided and sold to multiple fractional owners (Fiorentino & Bartolucci, 2021).

Healthcare

Smart contracts have the potential to improve data security, sharing and privacy in healthcare:

• Electronic health records – Patient health data can be securely stored and shared between providers using smart contracts, giving patients greater control over their information.
• Research data sharing – Clinical trial and research data can be easily shared between institutions using smart contracts while protecting patient confidentiality (Koulu, 2016).
• Pharmaceutical supply chain – Smart contracts can track and verify the origin and authenticity of drugs as they move through the supply chain.

Other Use Cases

Additional applications of smart contracts include:

• Voting systems – Smart contracts can enable secure, transparent and tamper-proof digital voting.
• Government and public records – Smart contracts provide an immutable and auditable record of government transactions and public records like land titles, birth and death certificates, etc.
• Intellectual property – Smart contracts can be used to register and protect intellectual property rights as well as automate the payment of royalties (Park et al., 2018).
• Fundraising – Smart contracts can automate the process of raising funds through initial coin offerings (ICOs) and ensure funds are only released if milestones are met (Ashari, 2020).

What are the limitations and risks of smart contracts?

While smart contracts offer many benefits, there are also risks and challenges to be aware of:

• Coding errors – Smart contract code may contain bugs or vulnerabilities that hackers can exploit. Due to the immutable nature of blockchains, it can be difficult and costly to modify contracts once deployed (Zupan et al., 2020).
• Legal uncertainty – The legal status and enforceability of smart contracts is still being determined in many jurisdictions. There could be potential conflicts between smart contract code and existing laws and regulations (Koulu, 2016).
• Lack of flexibility – Smart contracts are rigid and deterministic by design. They may not be able to accommodate complex contractual relationships that require a degree of flexibility and subjective judgment.
• Oracleproblem – Smart contracts cannot access data outside the blockchain on their own. They rely on external data feeds called “oracles”, which can introduce potential points of failure.
• Scalability – Current blockchain platforms like Ethereum may have difficulty scaling to handle high volumes of complex smart contract transactions (Koulu, 2016).

How Are Smart Contracts Transforming Business and Legal Contracts?

Smart contracts, enabled by blockchain technology, are poised to revolutionize how business agreements and legal contracts are executed and enforced. A smart contract is essentially a self-executing computer program that automatically performs the terms of an agreement when pre-defined conditions are met, without the need for intermediaries like lawyers or banks (Ahmadisheykhsarmast & Sönmez, 2020).

The immutable and transparent nature of smart contracts recorded on a decentralized blockchain can help ensure timely payments, reduce administrative costs, and eliminate disputes around whether contract terms were met. For example, a smart contract could be used to automatically release payment to a supplier as soon as a shipment is delivered, based on data from IoT sensors. This can help solve the pervasive problem of late payments in industries like construction (Ahmadisheykhsarmast & Sönmez, 2020).

Smart contracts are also enabling new forms of decentralized collaboration and commerce. Decentralized autonomous organizations (DAOs) are loose communities that come together to provide services to each other based on smart contracts. The lifecycle of a DAO collaboration, from initial negotiation to execution, can be governed by smart contracts in a transparent way agreed to by all parties (Norta, 2015).

What Are Some Emerging Applications of Smart Contracts?

Beyond automating payments, smart contracts have many other potential applications across industries:

• In supply chain management, smart contracts can be used in conjunction with IoT sensors and AI to dynamically optimize inventory levels and automate transactions between suppliers and buyers (Giovanni, 2019).
• Smart contracts can enable new data marketplace models by automatically enforcing data usage permissions and facilitating micropayments to data owners (Park et al., 2018). Reputation systems based on smart contracts can help enterprises trust the data being transacted.
• In the sharing economy, smart contracts can be used as new tools for urban governance. For example, transactions in a co-working space could be tracked on a blockchain, with data made available to city authorities for zoning and planning purposes (Fiorentino & Bartolucci, 2021).
• Blockchain-based smart contracts can streamline partnerships between businesses and NGOs in humanitarian supply chains, by improving transparency and reducing the need for trust (Baharmand & Comes, 2019).
• In crowdfunding, smart contracts can automatically distribute funds to a project once a funding goal is reached, increasing transparency for backers (Ashari, 2020).

What Are the Limitations and Future Potential of Smart Contracts?

While smart contracts have immense potential, the technology is still in its early stages. Translating complex legal agreements into code is challenging and smart contracts may have bugs or security vulnerabilities (Koulu, 2016). User-friendly tools for modeling, simulating, and verifying smart contract logic still need to mature (Zupan et al., 2020).

Looking ahead, the combination of smart contracts with AI, IoT, and other emerging technologies could unlock even more sophisticated automation of business logic. For example, an AI system could dynamically negotiate the terms of a smart contract based on real-time data, optimizing agreements on the fly. Smart contracts could also enable new decentralized business models that are more resilient and adaptable than traditional centralized organizations.

As smart contract platforms and tools evolve to become more secure, scalable, and easy to use, they will likely become a foundational infrastructure for the future digital economy. Many industries could be disrupted as key business logic and contractual processes are automated through smart contracts. The combination of blockchain and smart contracts is a powerful tool for increasing efficiency, transparency and trust – but realizing this potential will require ongoing collaboration between technologists, legal experts, businesses and regulators in the years ahead.

Tallyfy Tango – A cheerful and alternative take

Meet Alice and Bob, two tech-savvy friends who just discovered the wonders of smart contracts. Here’s how their conversation might unfold:

Alice: Hey Bob, have you heard about these smart contracts everyone’s talking about?

Bob: Yeah, they sound pretty cool! It’s like having a digital lawyer that enforces agreements automatically.

Alice: Exactly! No more worrying about someone not holding up their end of the bargain. The contract takes care of everything.

Bob: It’s like having a super-smart, incorruptible referee making sure everyone plays by the rules.

Alice: And the best part? No more mountains of paperwork! Everything is stored securely on the blockchain.

Bob: Imagine all the time and money we could save by using smart contracts for things like rental agreements or freelance work.

Alice: The possibilities are endless! It’s like having a trustworthy, digital handshake that can’t be broken.

Bob: I can’t wait to see how smart contracts change the way we do business. It’s going to be a game-changer!

Alice: Agreed! Let’s dive in and learn more about how we can start using them ourselves.

Related Questions

What are examples of smart contracts?

Some common examples of smart contracts include automatic payments when certain conditions are met, such as releasing funds from escrow once a property sale is completed. They can also be used for things like insurance claims, where a smart contract could automatically pay out if a specific event occurs, like a flight being delayed by a certain amount of time. Other examples include supply chain management, where smart contracts can track and verify the movement of goods, or even voting systems that ensure votes are counted accurately and securely.

What is a real example of smart contract?

One real-world example of a smart contract in action is the Ethereum-based platform Uniswap. It’s a decentralized exchange that uses smart contracts to facilitate the trading of various cryptocurrencies. When a user wants to make a trade, they interact with a smart contract that automatically executes the exchange of tokens based on predefined conditions, such as the current market price. This all happens without the need for a central authority or middleman, demonstrating the power and potential of smart contracts to automate complex processes securely and efficiently.

Can you make money from smart contracts?

Yes, there are several ways to potentially make money from smart contracts. One is by developing and selling your own smart contract applications, either to businesses or on open marketplaces. Another is by providing auditing or security services for smart contracts, helping to ensure they are free of bugs and vulnerabilities. You could also invest in projects or startups that are building innovative smart contract solutions. Finally, some smart contracts, like those powering decentralized finance (DeFi) applications, can provide opportunities to earn passive income through activities like staking or lending your cryptocurrency.

Is a smart contract legal?

The legal status of smart contracts can vary depending on the jurisdiction and the specific use case. In many countries, smart contracts are not explicitly recognized in legal frameworks, but they may be treated similarly to traditional contracts if they meet certain requirements, such as demonstrating a clear offer and acceptance. Some jurisdictions, like Arizona and Nevada in the US, have passed laws that give smart contracts the same legal standing as traditional contracts. However, there are still many gray areas and uncertainties when it comes to the legality of smart contracts, particularly in cases where they interact with real-world assets or services. As the technology matures, we can expect to see more clarity and standardization around the legal status of smart contracts.

References and Editorial Perspectives

Ahmadisheykhsarmast, S., & Sönmez, R. (2020). A Smart Contract System for Security of Payment of Construction Contracts. Automation in construction, 120, 103401 – 103401. https://doi.org/10.1016/j.autcon.2020.103401

Summary of this study

This study proposes a novel smart contract payment security system called SMTSEC to help eliminate or reduce payment issues in the construction industry. SMTSEC leverages blockchain technology to provide an automated, decentralized protocol that ensures timely, transparent payments for construction projects without the administrative overhead of intermediaries like lawyers or banks.

Editor perspectives

As a workflow automation platform, we find this study fascinating as it demonstrates how smart contracts can streamline complex payment processes in industries like construction. By codifying payment terms directly into the blockchain, all parties have full transparency and payments can be automatically triggered when milestones are hit, without manual effort or delays. This type of workflow is a perfect use case for smart contract technology.

Norta, A. (2015). Creation of Smart-Contracting Collaborations for Decentralized Autonomous Organizations. Lecture notes in business information processing, null, 3 – 17. https://doi.org/10.1007/978-3-319-21915-8_1

Summary of this study

This paper formalizes the lifecycle of setting up smart contract collaborations between decentralized autonomous organizations (DAOs). It covers the negotiation phase where DAOs populate collaboration blueprints with service offers, potentially leading to a consensual smart contract agreement. The formalized model fills a gap in defining this setup process.

Editor perspectives

The concept of DAOs collaborating via negotiated smart contracts is powerful. As a workflow platform, we’re excited by the potential for organizations to automate their interactions and reach agreements without human intervention. Formalizing this lifecycle is an important step towards realizing the vision of self-governing DAOs dynamically forming business relationships.

Park, J., Youn, T., Kim, H., Rhee, K., & Shin, S. (2018). Smart Contract-Based Review System for an IoT Data Marketplace. Sensors, 18, 3577 – 3577. https://doi.org/10.3390/s18103577

Summary of this study

This study proposes using Ethereum smart contracts to implement a review system for peer-to-peer IoT data marketplaces. The system allows data marketplace participants to confirm the reputation of data owners and the quality of data being traded. Putting reviews on the blockchain provides security, integrity, and immutability compared to centralized alternatives.

Editor perspectives

Trust is critical in any marketplace, especially in decentralized contexts. As a workflow company, we appreciate how this smart contract review system helps establish trust programmatically, without relying on a central authority. Buyers can have confidence in who they’re transacting with and what they’re purchasing. It’s a clever use of blockchain to solve a real business problem.

Koulu, R. (2016). Blockchains and Online Dispute Resolution: Smart Contracts as an Alternative to Enforcement. SCRIPT-ed, 13, 40 – 69. https://doi.org/10.2966/scrip.130116.40

Summary of this study

This article examines how self-executing smart contracts on the blockchain could be used for online dispute resolution (ODR) and enforcement of ODR decisions. It provides an introductory analysis of the legal implications of blockchain technology beyond cryptocurrency, using a programmable weather bet smart contract as an illustrative example.

Editor perspectives

Dispute resolution is a critical part of many business workflows, but can be difficult to manage across jurisdictions. As a workflow automation company, the idea of encoding dispute resolution and enforcement logic into smart contracts is incredibly compelling. It could make resolving issues faster, cheaper, and more consistent. This article provides a thought-provoking introduction to the possibilities.

Lee, W. (2019). Beginning Ethereum Smart Contracts Programming. Apress eBooks, null, null – null. https://doi.org/10.1007/978-1-4842-5086-0

Summary of this study

This book provides a practical guide to writing, testing, and deploying Ethereum smart contracts, as well as building web applications that interact with them. It aims to enable readers to get started with smart contract development without needing to wade through extensive documentation, assuming only basic programming knowledge.

Editor perspectives

For those of us excited about the potential of smart contracts to revolutionize workflows, resources like this book are invaluable. By making it easier for developers to get hands-on with smart contract programming, it will accelerate the creation of real-world blockchain applications. We look forward to seeing the innovative ways people apply this knowledge.

Glossary of terms

Smart contract

A smart contract is a self-executing contract with the terms of the agreement directly written into code. It automatically executes when predetermined conditions are met, without the need for intermediaries. Smart contracts are stored on a blockchain, making them immutable and transparent.

Blockchain

A blockchain is a decentralized, distributed ledger technology that records transactions across a network of computers. Each block in the chain contains a number of transactions, and every time a new transaction occurs, a record of that transaction is added to every participant’s ledger. This makes the blockchain an immutable, transparent record of all transactions.

Ethereum

Ethereum is a decentralized, open-source blockchain platform that enables the creation of smart contracts and decentralized applications (dapps). It has its own cryptocurrency called Ether (ETH). Ethereum’s programmable smart contracts have made it a popular platform for a wide variety of applications.

Decentralized autonomous organization (DAO)

A DAO is an organization represented by rules encoded as a computer program that is transparent, controlled by the organization members, and not influenced by a central government. DAOs operate on a blockchain network, leveraging smart contracts to automate governance and decision-making.

Solidity

Solidity is an object-oriented, high-level programming language for implementing smart contracts on various blockchain platforms, most notably Ethereum. It is designed to target the Ethereum Virtual Machine (EVM). Solidity is statically typed, supports inheritance, libraries, and complex user-defined types.