Blockchain-based smart contracts can streamline routine business transactions. Find out how cryptocurrency factors into smart contracts.
Blockchain has been in the headlines for years as the “next big thing” in technology, yet like augmented reality, 3D printing and 5G, the promise has not met reality outside of a few specialized applications. This could be changing with the increased adoption of blockchain-based smart contracts.
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What is a contract?
Contracts are a fundamental element of any commercial relationship. Contracts could be a simple agreement that stipulates how many bags of cement I purchased from you and at what price, or wildly complex documents that detail a transaction with holdbacks, performance guarantees and nuanced payment terms. Distilled to its essential elements, a contract is an agreement between one or more parties that if an event occurs, some amount of value will change hands.
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Traditional contracts are documents that rely on manual intervention at some point. For example, consider a basic purchase order, which is a contract that one party will buy a certain quantity of goods at a defined price. When those goods are shipped, the seller sends an invoice to the receiving party, who verifies the quantity and quality of the goods received, matches the invoice to the purchase order and issues payment. The seller needs to manage a collections process for the amount, which might range from simply matching a payment to the order to complete the contracted transaction, or repeatedly invoicing the buyer and perhaps even launching collection efforts if the bill remains unpaid. While many of these steps are automated at most organizations, there is a significant human effort to process exceptions and audit the various stages of the process.
What is a smart contract?
A smart contract adds two critical elements to a traditional contract that stipulates the terms of a transaction:
- Value (e.g., money) is embedded in the contract using some form of cryptocurrency.
- The “business rules” of the contract are embedded in the digital document and automatically verified.
In the example above, if the parties used a smart contract, the cost of the goods would be embedded in the smart contract. Similarly, the smart contract would contain a trigger when the buyer scans the goods into their inventory system. Once that trigger is completed, the smart contract releases the value it holds, paying the seller without requiring any invoicing or collections.
An example of a smart contract might be a flight cancellation insurance policy. Many of us have purchased these policies, which purport to pay a fixed amount if your flight is delayed past a certain threshold. Redeeming these policies usually takes making several phone calls, providing documentation and following a process that’s painful to the point that many of these policies go unredeemed. Imagine purchasing a smart contract-based policy. Since flight data are broadly available, the contract would be linked to a specific flight. As soon as flight data indicated the flight had been delayed past the contracted five hours, it would automatically release its value, and the policyholder would immediately be paid.
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An important detail about smart contracts vs. traditional contracts is that the former rely on the legal jurisdiction in which they were created. If one party does not fulfill its side of the contract, the threat of legal action is essentially the ultimate recourse. However, since a smart contract has the monetary value and release triggers embedded in a digital document, it doesn’t require the aid of any legal system, as value is automatically released when the conditions are met. Thus, as long as the smart contract is well-designed and the supporting blockchain is reliable, the technology essentially provides the assurance that previously relied on the courts.
What are the biggest benefits of using smart contracts?
Smart contracts reduce the millions of hours spent monitoring and mitigating the thousands of agreements that most businesses require to perform their activities. Smart contracts promise to make anything from a simple sales transaction to a complex insurance policy significantly easier to monitor and fulfill, all without the costly recourse of the legal system.
What’s more interesting perhaps is that smart contracts could disrupt or reconfigure several industries. For instance, the insurance industry largely relies on an extremely difficult to acquire asset: trust. Since a smart contract has value embedded inside it and performance conditions that are automatically triggered, the trust shifts from the reputation of perhaps a centuries-old company to the technical implementation of the smart contract. A well-funded startup could theoretically issue all manner of novel insurance policies based on smart contracts, using technology to eliminate questions about the trustworthiness or longevity of the brand since the smart contract is what pays out the policy, not the company.
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Read up on smart contacts, as you’ll likely be implementing them in the near future to streamline routine transactions. You may also identify areas where your company is uniquely positioned to reshape its industry through smart contracts, and your leadership could spur wholesale change in the market.