By definition, a contract is "an agreement between two or more parties that creates a legal obligation to execute actions in accordance to the agreed upon terms.” Previously, contracts were almost always written on paper and had to be agreed to by both parties to be binding. However, with the advent of blockchain technology and smart contracts, we’re now seeing a major change.
But, what are smart contracts, and why are they becoming increasingly important?
What are Smart Contracts?
Smart contracts are a new way to execute transactions with no third-party involvement. They use computer-automated contracts to execute the terms of an agreement between multiple parties. They facilitate the validation, control, and execution of an agreement, and all processes take place on a blockchain platform—without human intervention.
Like traditional agreements, smart contracts define agreement parameters and enforce the obligations per the commitments. Three parties form the basis of smart contracts:
Signatories—the agreeing parties that digitally sign smart contracts to validate the contractual terms.
Contract subject—what's at stake.
Contract terms or conditions.
All smart contract execution data remains in the public record through blockchain's immutable status, making them a secure, fast, and cheap way of contract management.
How do Smart Contracts Work?
Smart contracts follow the "if/when…then…" statement. For example, if party A fulfills obligation B, then party B releases object A. This is best encapsulated by the vending machine analogy. To get a snack from the vending machine, the correct money and snack selection are required. The vending machine removes the need for a vendor employee.
Participants define the agreement terms, which are then written into lines of code on the blockchain. If each party fulfills the predetermined conditions, a network of computers executes the transaction per the agreement. Once complete, the blockchain updates to acknowledge that the transaction was successful. The data remains immutable (can’t be changed), with the agreeing parties receiving exclusive access to the transaction results.
Smart contracts give you the flexibility to define the agreement terms. However, creating smart contracts for every agreement can be cumbersome; therefore, developers and organizations provide templates to help you tailor your desired contract terms.
Popular Smart Contract Platforms
What are the Benefits of Smart Contracts?
1. Trust and transparency
Smart contracts operate independently; no third party contributes to the execution of the agreement. All parties receive the encrypted information, ensuring no one manipulates the contract data for their benefit.
Smart contracts run on blockchain platforms, ensuring transactions remain encrypted and immutable. Therefore, the agreement information remains secure from bad actors. The transaction records also connect to previous transaction records, bolstering data security.
3. Accuracy, Speed, and Efficiency
Smart contracts are automated and execute transactions once the predetermined conditions are fulfilled. The execution is accurate, fast, and efficient, as there’s no paperwork or third-party involvement, resulting in accurate and efficient processes.
4. Reduced Costs
Smart contracts can organize and categorize paper contracts to improve process efficiencies and streamline administration and management. Contract management and standardization reduce risk, which ultimately saves costs. Having consistency within your contracts ensures standards are adhered to, lowering financial liability and/or expensive compliance failures.
These benefits make smart contracts ideal for industries in various economic sectors—from government voting systems to healthcare and financial services to supply chains. Smart contracts can improve security, efficiency, and overall production cost.