WELCOME TO THE FUTURE OF FINANCE

What is a smart contract?

Smart contracts are digital transaction protocols that verify, control, and self-execute an agreement, embedded in computerized codes on a blockchain, if parties meet predefined rules. Unlike traditional (physical) ones, these contracts occur among anonymous parties and are enforced automatically without the involvement of any third party.

They have three main components – signatories (parties), subject of the contract, and contract terms. The parties involved must satisfy the terms of the agreement (a set of rules and penalties) for a successful transaction. Besides eliminating the need for an intermediary, executing agreements through digital contracts is considered cost-effective and secure. More so, the decentralized blockchain network ensures that transactions remain transparent, traceable, and irreversible.

• There are two parties (a buyer and a seller) interested in buying and selling an asset.

• These two parties enter a smart contract, a wholly digital and self-executing agreement, with its terms or clauses written in codes on a decentralized blockchain network.

• These codes specify the agreement’s terms, which both parties must agree to for the contract to be automatically enforced. The transaction occurs when parties meet these terms and rules.

• The smart contracts platform offers complete transparency and high-end security. Also, it restricts tampering of the data and allows the two parties to track the transaction. The identities of the parties involved, however, remain confidential.

Smart contracts examples are common in industries like property rights, intellectual property, banking and insurance, legal services, e-government, crowdfunding.., etc.

To understand the concept better, let us consider the examples below:

• A group of investors proposes to fund a business project idea from the ABC team. Both enter a smart contract, which codifies the terms and lists down a set of rules and penalties around it. If the project idea seems valid per the codes, the blockchain will transfer the money to ABC. On the other hand, if the project idea seems unsatisfactory per the contract terms, the blockchain will return the money to the group. In this example, the contract stores and validates transaction information and self-executes the contract only if the relevant event triggers.

• Another practical example is when a buyer agrees to pay a seller for delivering some goods at a specified date. The contract outlines rules for the amount to be paid and the delivery of goods on a particular date. However, the blockchain will hold the transaction if either party fails to meet its obligations.

Smart or blockchain contracts are unique in the way that they ensure compliance between the two parties. Immutability is one of the most remarkable features of a self-executing contract. It means it is impossible to reverse, alter, or tamper the codes, rules, and even the transactions once programmed on the blockchain.

Since these are computer programs, the automated execution of agreement happens as per the codes (contract terms) and rules defined. However, if there is still a need to update these codes and conditions, there are a few indirect ways that might help:

• Create an intermediary contract containing transaction details, such as the address, of the existing contract. Thus, any transaction made using the intermediary contract will be redirected to the active one.

• Program a new contract version and import all of the existing contract’s codes, conditions, and transaction data into it.

• Store the logic code of the existing contract in a library and use it to recall the terms, rules, and transaction data of the active agreement.

There are three types of self-executing contracts based on their applications:

#1 – Smart Legal Contracts

These contracts are legally enforceable and require the parties to fulfill their contractual obligations. Failure to do so may result in strict legal actions against them.

#2 – Decentralized Autonomous Organizations

These are blockchain communities that are bound to specific rules coded into blockchain contracts combined with governance mechanisms. Hence, any action taken by the community members gets replaced by a self-enforcing code.

#3 – Application Logic Contracts

These contracts contain an application-based code that remains in sync with other blockchain contracts. It enables communication across different devices, such as the merger of the Internet of Things with blockchain technology.

Special thanks for a fantastic article as published by wallstreetmojo.com