Smart Contracts

What are smart contracts?

The idea of Smart Contracts was first introduced by Nick Szabo, a famous cryptographer, in 1996. At the time, there was an early version of blockchain called Linked Timestamping. Szabo realised that this would allow for contracts to be made on it, without the need for any middlemen, which would create cost and time savings, and reduce the risk of human error.

Smart Contracts are self-executing digitized versions of normal legal contracts, as are used in the real world every day. This means that they work exactly the same as any other legal contract, with the difference that they can be digitally pre-programmed with set criteria, so that parts of the contract can be automatically executed when these certain things happen.

Smart contracts being self-executing means that they effectively serve the same purpose as traditional paper contracts- but are able to provide functions not otherwise possible with paper contracts- such as releasing monies held as soon as trades or logistics reach a certain stage. All sorts of clauses can be built into Smart Contracts- such as a date being reached or action happening. They can be fully customizable, and as such the contracts can be designed to be expensive or difficult to breach.

Smart contracts work entirely digitally, and on the blockchain, so they do not rely on solicitors or third parties to do anything. The initial legal contracts they are built on will usually be designed by lawyers, to ensure that they meet the legal requirements of the jurisdiction they work in. However, once the initial contract has been drawn up, the smart contracts do not have to wait on humans to do anything, and the legals of the smart contract itself can be reused or personalised over and over again. Smart Contracts are able to achieve with code, what it often costs a lot of money to pay to produce a solicitor to write out in a worded contract. This is one of their biggest benefits- lawyers cost a lot of money, take a lot of time, and as they are human, are capable of making mistakes or needlessly delaying transactions. Once a smart contract has been drawn up, it can provide huge cost and time savings, as well as allowing users to customise the contracts to suit their exact requirements, and minimise the risk of any human errors or delays.

Smart Contracts are designed to make traditional contracts more secure. Because they operate entirely on the blockchain, all transactions relating to the contract can be seen by anyone looking at that blockchain, and cannot be changed. This helps protect against loss or manipulation, as everyone can see every stage of the transaction. They effectively serve the same purpose as traditional paper contracts- but are able to provide functions not otherwise possible with paper contracts- such as releasing monies held as soon as trades or logistics reach a certain stage.

Ethereum and Smart Contracts

Ethereum was built in order for these Smart Contracts to be able to operate on the blockchain.

Whereas the first smart contracts were technically built on the bitcoin blockchain, the Bitcoin blockchain’s use is limited to Bitcoin. Ethereum is much more flexible and was designed for this purpose of opening up smart contracts to everyday use, and Smart Contracts are now much more easily accessible.

Whilst smart contracts can be created on any blockchain, Ethereum is the most commonly used due to its unlimited processing capability and its flexibility.

In its simplest form, Ethereum is a platform that allows applications and smart contracts to be built on it that are able to execute trades and agreements without the need for a third party.

Trade / Orders / Supply Chain

One of the main uses of Smart Contracts will be in trade and logistics – especially by being able to cut out the need for third parties.

Example:

Many ICOs will claim that they will “disrupt the market” in one way or the other.

Bob, in the UK, buys 10x woolly jumpers for $200 from Sally in the USA.
Bob and Sally agree that Sally will send the jumpers with the carrier ABC Logistics and that
Bob will have to pay for the jumpers before they are sent.

In this instance, Bob has to trust both Sally and ABC Logistics. Sally– to send the jumpers on time and in the condition specified, and ABC Logistics – to bring the jumpers safely to him, on time, and in the same condition.

If anything happens to the jumpers en-route, if ABC Logistics prove to be unreliable, or if Sally doesn’t send the correct amount of jumpers or if they are not in the condition he was told they were in when he bought them, Bob either has to arrange a return shipment at his expense, or hope that Sally offers him a refund or another free shipment.

For Bob to ensure that he receives his 10x woolly jumpers and doesn’t have to pay any more than $200, he arranges for his bank to send the money to Sally’s bank – affording him a level of protection, and also pays for an independent insurance. The cost of sending the money internationally via his bank and the cost of the insurance add up to another $25, meaning in total he has to pay $225.

With a Smart Contact:

For this same example, Bob orders the same 10x woolly jumpers for $200 from Sally.

However, this time Bob sets up the agreement using a smart contract. Bob puts $200 into escrow via the smart contract. The smart contract releases $75 to Sally when she has signed the contract with ABC Logistics via the Smart Contract. The Smart Contract is automatically informed when the ABC Logistics shipment reaches UK customs, which automatically releases another $50 from Bob’s escrow to Sally. When the jumpers are signed for by Bob when they reach his house, the mail company updates its records which automatically triggers the release of the remaining $75 to Sally.

Voting

If people could vote in a smart contract – it would reduce the risk or any accusations of voting being rigged, but also, if everyone could vote securely from home straight onto a smart contract and not have to go to a polling station, it might increase voter turn out.

Smart Property

Smart Contracts can be embedded into physical objects- such as cars or houses for example – by effectively locking them up with a code – and the car/ house/object can’t be unlocked without the correct private key or code – either by the owner or which could be loaned by the owner in the case of a rental.

This can replace the purpose of a key deposit box – whereby where for some rental houses – the key is locked in a safe outside the house and can only be accessed via a key/ code given to the renter by the owner or agent.

Some examples of how Smart property contracts can be used on cars:

  1. To insure against theft of one’s own car – the car is inoperable unless accessed via the private key/ code held by the owner. This also would prevent against the selling of a stolen car, as the car would have no value to the potential buyer without the private access key code (this is different to the physical car key and effectively serves as a second and extra secure level of key protection).
  2. To allow people to arrange a car rental online, and be able to access the car without needing to meet with a human representative of the company. In this case, car rentals can be made cheaper and can be 24/7 rather than being dependant on office opening hours as they are now. The hire car can then be rendered inoperable at the end of the contract (and show it’s GPS location) unless the term is extended in advance by the renter – this prevents the risk of lost payments made by non-timely returning of the car. Additionally, say for example the car rental company doesn’t release the private key in time for the start of the rental contract, the escrow payment is automatically returned to the renter by the smart contract.
  3. If a loan is used to buy a car, the car can be rendered inoperable if loan payments stop being made. The private access key /code is then returned automatically back to the car-loan provider. This is cheaper and quicker than repossessing the car and reduces the risk for car loan providers.
  4. In the case of buying a used car, the car’s history can be seen via a smart contract unlike now where it is easy to hide the history of a car and end up buying a car with more problems than advertised.