Why Are Smart Contracts So Smart?
Bitcoin and NFT’s are some of the first mainstream applications for Smart Contract technology. For example, the transfer of a Bitcoin or the sale of an NFT requires code that can verify and execute that transaction. That code comes in the form of a Smart Contract. Smart Contracts in their simplest form, store rules, verify those rules, and self-execute those rules. Unlike conventional contracts that contain ambiguous language and can be manipulated to the benefit of one side of the contract. As well as the legal application of smart contracts, this technology can be used by corporations that see millions of transactions a day due to its incorporation with Blockchain. The immutable nature of smart contracts has opened doors for many applications of this technology, including real estate, healthcare, and financial exchanges such as lending and borrowing, trading, or investing. Keep in mind while you read this article that there are still many limitations and barriers this technology faces, but if the problems are fixed, Smart Contracts will shake up major industries.
Understanding how Smart Contracts work is understanding how Blockchain, the system that allows for smart contract applications, works. Blockchain is a decentralized, distributed ledger technology (DLT). In other words, Blockchain is a public network of transaction records and data that is brilliantly secure. The system works by “packaging information into blocks and adding them together in sequence to form a chain. This chain is then shared over many computers or ‘nodes’ to ensure that as many people as possible have a copy to ensure data integrity”(Horizon State 2020). The chain is secure in this way because multiple copies on multiple nodes means one node can be compared to another to verify if the chain has been compromised or hacked. If compromised, the system will invalidate that copy of the chain, rendering the hack useless. Moreover, each new block on a chain contains a cryptographic hash, which is a one-way function that is almost impossible to change (immutability). A timestamp and transaction details are recorded into a block as well, which is extremely useful for businesses to track any good or product or transaction they desire. For example, “IBM has created its Food Trust blockchain to trace the journey that food products take to get to its locations”(Conway 2021).
A specific form of smart contracts, Smart Legal Contracts, are a revolutionary form of legal agreement. The proof of the concept is predicated on the fact that the information cannot be changed or manipulated to one person's gain. The fixed functions of the smart contract that are encoded on-chain(blockchain) are binding to the parties involved, they cannot be altered. Smart Legal Contracts require no third party, a lawyer in this case, to mediate the contractual process. Smart contracts are enforced by code, unlike conventional contracts which are enforced by law. Law is enforced after fraud is committed, code ensures fraud isn’t committed. The security of smart contracts could possibly prevent the “FBI estimate of $40+ billion in non-health insurance fraud stolen each year”(Capgemini 2016). On top of savings from fraud, the fees saved from the lack of a legal third-party could potentially increase that number even more.
Other use cases for smart contracts include cutting costs for all involved in the mortgage lending market. With the implementation of blockchain technologies, lenders are looking at massive cuts in processing costs. It is estimated that “banks would be able to cut between $3 and $11 billion annually by lowering processing costs in the US and EU alone” (Capgemini 2017). Most people would consider this a significant sum that is sure to force the adoption of Blockchain in the financial industry.
The immutability, transparency, speed of transactions, and more importantly, the risk-reduction of transactions conducted with Smart Contracts is what has attracted “40 global banks and Wall Street to give proof-of-concept testing for their organizations”(Conway 2021). These banks that see the potential of smart contracts are either looking to use the technology to replace manual processes or partner with financial technologies (fin-tech) companies that can operate independently under the bank's existing systems and customer network. “Barclays Corporate Bank, for instance, has recently partnered with a startup platform Wave. It uses Blockchain to store bill-of-lading documents and smart contracts to automate log change of ownership and payment processes”(Conway 2021). Wave is utilizing the function of smart contracts called ‘digital signatures’. Through digital signatures, signatures that prove to the other nodes in the system you are authorized for that transaction, Smart Contracts can quicken time of documentation and workflow alike. A crucial aspect of banking that is looking to modernize.
The overall benefit of using smart contracts for financial exchanges is the speed at which the process can function while “mitigating the risks, including manual human error and duplication of invoice financing”(Polyswarm 2018). Financial corporations stand to decrease, by millions, on operating costs and spending on manual data processing. It is not unusual for large banks to “spend upwards of $500 million on programs to address the challenges related to data, yet it is widely acknowledged that these investments have not been translated to increased profits” (Belinky and others 2016). The benefit would also be reaped by customers. Not only will Smart Contracts create quicker, seamless, and accurate transactions, they will save money on both sides of the exchange. “Capgemini, a French consultancy, estimates that consumers could save up to $16 billion in banking and insurance fees each year through blockchain-based applications”(2017). A prime example being international payments or the stock exchange. A transaction or trade that could take days to process, could take minutes on Blockchain. Some of this processing speed comes from bypassing existing international payment networks. Again, this eliminates the mediary.
Another exciting use-case for Smart Contracts is real estate. Real estate stands to benefit from this technology in both the transfer of property and insurance. On the insurance front, a common issue when buying a home is the risk associated with the transaction of hundreds of thousands of dollars. With a transaction of this size, a seller is hesitant to transfer the property before receiving funds and vice versa. When risk arises a third-party is usually sought out, such as notaries, which only adds to the cost of buying a property and slows down the process. Smart Contracts can solve the issue of security as well as operate as an autonomous broker for the transaction. Of course, brokers and agents may still be involved given the physical involvement that software cannot replace. A Smart Contract is not able to determine the quality of construction of a property or, in the case of a rental property, code cannot verify that a renter moved out of their apartment without a physical inspection. Besides that, smart contracts can ensure a binding trust between parties. The processing application, too, can streamline the loan process, reduce processing charges, and result in a quick transfer of the title deed to the new owner. This transfer of property is already being realized in the form of NFTs.
In the purchase of art as an NFT, it is not the art that holds the true value within the exchange, it is the non-fungible token or NFT for short. This token, exchanged through a smart contract, cannot be replaced or replicated. The owner of the token verifies ownership of the art no matter who can view the piece. This is relevant to the real estate application of Smart Contracts because the process of selling art as an NFT may soon be realized in the process of selling a home. Proving to be a reality, in 2017, Propy sold their first ever property as an NFT. The Ukrainian apartment was completely bought and sold online using their platform. Propy too, claims the process through their system saves 10 hours of processing, per transaction.
Voting may be a less prevalent, although significant use-case of smart contracts. Voting may be one of the most important, relevant, and influential actions a citizen can take, in any country. Yet, across the globe, competitive elections on any level experience miscounting, tampering, and fraudulent voting. The fear of hacking and tampering by foreign entities has prevented voting from making the switch to an online process. However, a solution may be realized through Smart Contracts which protect against external threats to the network. Through a smart contract, citizens could vote using a token, like a person may transfer one bitcoin to another. Encoded in the token can be a predetermined set of conditions that allows the owner of the token to transfer it to the name of the candidate they wish to vote for, anonymously of course. In this fashion, counting will be autonomous, quicker, more trustworthy, and there won’t be worry of ballot boxes burning or hours of filing ballots by biased workers with the risk of human error looming. Horizon State is a company that is already testing the use of this technology. Their website explains the process best, “when you cast a vote, you vote using a cryptographic ‘hash’ of your own, which will serve as a unique code to identify your vote. Everyone will be able to see the vote made using this hash, but only you will know it belongs to you”(2020).
Privacy may have been solved by Horizon State through voting, but the issue stands as one of many problems that needs solving before Smart Contracts and Blockchain become adopted by major and minor corporations alike. The Blockchain system is designed to be transparent and public. Unfortunately, customers probably don't want their financial transactions open to the public, no matter how secure. After privacy, the next problem is the interoperability of Blockchain with legacy systems. Most organizations will not and can’t afford to throw away their existing systems. The blockchain will not work directly with private, centralized systems because it would defeat the purpose of a decentralized network. Blockchain needs to work through oracle networks or ALC’s(Application Logic Contracts) or other mediaries to allow blockchain to interact with existing systems. Private systems, especially on the scale as large as banks, may struggle to integrate. A final issue that has slowed the integration of Blockchain is that the speed at which transactions are processed has not yet reached the desired criterion for companies to take Blockchain seriously.
In time these issues will be tackled and some have already begun to be fixed. Take the recently updated version of Ethereum, a major blockchain that powers cryptocurrencies and applications for smart contracts. Their update came with a serious solution to the processing speed of transactions: sharding. Sharding describes breaking up the chain into different ‘shards’ and appointing each shard responsible for processing part of the data stored in the system. Everyday, more solutions like sharding are implemented to solve Blockchain’s fallbacks. Even with the current fallbacks, start-ups are popping up everywhere that are using smart contract technology to change the way we do business. Smart Contracts are a technology that is poised to shake up industries by revolutionizing the way we process data, make financial transactions, and exchange goods or property. This tech is here to stay. “Major corporations such as Walmart, Pfizer, AIG, Siemens, and Unilever”(2021) have already incorporated Blockchain technologies into their systems and more organizations will follow. I hope this article excites you for the future and encourages you to pay attention to Smart Contracts and Blockchain before an opportunity passes you by. The future is here and it is far Smarter than we can imagine.
References
Fridman, Lex. Sergey Nazarov: Chainlink, Smart Contracts, and Oracle Networks. Other. Lex Fridman Podcast, no. #181, May 1, 2021.
Belinky, Mariano, Emmet Rennick, and Andrew Veitch. “The Fintech 2.0 Paper: Rebooting Financial Services.” Finextra. Anthemis Group, 2016. https://www.finextra.com/finextra-downloads/newsdocs/the%20fintech%202%200%20paper.pdf.
“Blockchain.” Horizon State, July 22, 2020. https://horizonstate.com/product/blockchain/.
Conway, Luke. “Blockchain Explained.” Investopedia. Dotdash, September 21, 2021. https://www.investopedia.com/terms/b/blockchain.asp#what-is-blockchain.
PolySwarm. “5 Companies Already Brilliantly Using Smart Contracts.” Medium. PolySwarm, April 25, 2018. https://medium.com/polyswarm/5-companies-already-brilliantly-using-smart-contracts-ac49f3d5c431.
Rupareliya, Kamal. “How Smart Contracts Are Transforming Banks and Financial Institutions.” Business of Apps. BusinessofApps, July 8, 2021. https://www.businessofapps.com/insights/how-smart-contracts-are-transforming-banks-and-financial-institutions/.
“Smart Contracts in Financial Services: Getting from Hype to Reality.” Capgemini. Digital Transfer Institute, 2016. https://www.capgemini.com/consulting-de/wp-content/uploads/sites/32/2017/08/smart_contracts_paper_long_0.pdf.
“Consumers Set to Save up to Sixteen Billion Dollars on Banking and Insurance Fees Thanks to Blockchain-Based Smart Contracts Says Capgemini Report.” Capgemini Worldwide. Rightshore, July 15, 2017. https://www.capgemini.com/news/consumers-set-to-save-up-to-sixteen-billion-dollars-on-banking-and-insurance-fees-thanks-to/.