Background to Smart contracts
The idea of Smart contracts was first developed by Nick Szabo in 1996. Szabo’s concept was to create protocols to transfer data using complex mathematical algorithms. These algorithms would automatically process transactions if certain conditions were met. The process would be a fully automated one. In 1996 the technology did not exist for the concept to be fully realized and put into practice.
In 2008 Bitcoin cryptocurrency was conceived and with it came blockchain technology which was a digital, distributed and decentralized database also known as the distributed ledger. This development would lead to the platform for the creation and development of Smart contracts. A few years later the Ethereum platform appeared and this would make it possible for Smart contracts to be developed, used and put into practice. Smart contracts were designed to be stored on the blockchain, be fully automated and could either replace or substitute traditional contracts. Program languages like C++, Python and Java amongst others can be used to program Smart contracts. The same rules that apply to any legal contracts also apply to Smart contracts i.e. the same legal obligations, penalties, rules and benefits. Smart contracts also provide additional security, reduces costs and delays that can be associated with traditional contracts.
How Smart contracts work
A traditional ledger in any organization would be used to record transactions, trace assets, investments, and inventory. This would mean that several ledgers would need to be maintained across the organization and this would cause duplication of effort. Because theses ledgers would be stored on a central system it would also be susceptible to cyber-attacks, fraud and network downtime
Smart contracts are computer programs that run on top of Blockchain technology and allows all the participants to share and interact with each other using a distributed ledger, agreement or transaction. Smart contracts are shared between individuals that run the code independently and then automatically cross-checked. The blockchain ledger ensures that all the inputs in the program are identical when the program is executed. When the participants execute program they should all come to the same conclusion which is then recorded on the distributed ledger. Smart contracts operate by following a simple rule IFTTT “if this then that statements”, if this happens then execute the next sequence of events programmed into the Smart contract on the Blockchain. Because the blockchain is secure and reliable it ensures that the transactions that happen cannot be changed, modified or edited.
A simple example of a Smart contract could be compared to vending machine.
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Step 1 . A person would insert cash into the vending machine to make a certain purchase
Step 2. the money inserted triggers an event where the vending machine enables
the person to key in the code for the item the user wants to purchase
Step 3. the person makes the selection for the desired item on the keypad
Step 4. the vending machine then executes the selection and released the product
with correct change if any is due
Step 5. the person collects the product and any owed change
Step 6. Transaction successfully completed and both parties are satisfied
Smart contracts operate on the same principle – code is designed to trigger a response when certain agreed conditions are met, transaction rules are enforced and verified and the transaction is processed.
Benefits of Smart contracts
Trust – no third-party intermediaries are needed this allows for full control over the agreements
Accuracy – a Smart contract records all the terms and conditions in explicit detail
Transparency – the details of the Smart contract are visible to all relevant parties
Security – Smart contracts runs on the Blockchain and it allows for those transactions to be run very quickly
Security – Smart contracts will use the same security that crypto currencies use
Paper free – no paper required for Smart contracts – no impact on the environment
Three examples of implementation of Smart Contracts
Smart contracts in Real Estate
Buying, renting or leasing property is still a time consuming, tedious and very inefficient process. These processes are largely paper based and still in the hands of real estate agents, banks, lawyers and the registration at a deeds office. This can lead to false listings, rental scams and other fraudulent transactions. To address these inefficiencies, Smart contracts can be used to address, assist and bridge all these entities and persons involved in the process.
Current process when renting a property
Choose an agent
Search for rental property that you like or interested in
View properties available for rental
Ensure credit score is sufficient to qualify for rental agreement
Search for rental property that you like or interested in
Negotiate terms of rental agreement
Smart contracts can address some of the requirements listed above
Rental property searches through the Blockchain can be done using a Multi Listing System – The MLS (Multi Listing Service) enables potentials lessees to view properties based on their requirements.
Blockchain digital identities of assets and individuals can be used to conduct a background check on the lessee
Terms and conditions of the agreement can be recorded on the blockchain i.e. a Smart contract is created
The Smart contract can initiate payment of the security deposit via a bank account
Transaction is agreed upon by both parties and is officially recorded
When lease/rental agreement has completed it term the Smart contract can initiate the transfer of the security deposit to the lessee
Smart contracts in the Insurance industry
Insurance has been considered as a “grudge purchase” by consumers and can only be tested once a claim has been submitted. The person makes regular payments while the insurer makes a promise to cover if or in case of possible damage. The flaw in this arrangement is that both parties don’t trust each other. Current insurance flaws include:
Inefficient information between client and insurer
Use of a middleman i.e. broker
Manual claims process
Delay in claims being processed and payment being made
Smart contracts are able to bridge the gap between insurers and clients by offering the following advantages
Correct risk evaluation of clients because of detailed records
Lower administration cost – fewer underwriters required
Lower prices – the risk associated with each client is unique and policies can be tailored according to the risk profile of each client
Fraudulent claims can be detected earlier
Automatic payments after uncontested claims are processed
Secure distributed database of policy documents
The thing to remember is that insurance companies incur costs even with the smallest contract that they setup. These costs are eventually absorbed by the consumer in the form of higher premiums. Smart contracts have been shown to be beneficial to the insurance industry by streamlining several activities and also offer clients transparency, trust and cost saving implications.
Life insurance is one if the simplest “if, then” policies that can be used on Blockchain using a Smart contract. Once the policy holder has died the life insurer then pays out to the surviving family members. The policy usually requires proof of the deceased in the form of a death certificate and several documents needs to be completed before the policy can be paid out. The problem arises if the policyholder has several life insurance policies with different life insurance companies. Policy documents can be misplaced, lost or destroyed in fires or floods. Smart contracts can alleviate the problem by digitally storing the contract in the ledger on the Blockchain. This would allow the policy to be available to the policyholder, any beneficiaries and the insurance company. An oracle can be configured to work with numerous blockchains, external sources, and any necessary entity involved with automating the execution of the smart contract.
Final expenses insurance
This is a type of insurance where a fixed amount is paid out upon the person death to help cover expenses like costs. The Smart contract can perform the same function as that of a Life insurance smart contract.
Smart contracts in the Energy Industry
Several startup companies are already looking at using the Blockchain and Smart contracts to streamline the distribution of electricity to consumers. The idea is to use solar panels that are spread across rooftops that generate electricity and get them to sell-off excess electricity from their systems to buyers in the group, which could be consumers or people living next door. This would be an energy trading system using Smart contracts built on the blockchain. Users would bypass the conventional energy grid, build a micro grid which would include storage components and even be used during power failures. This would take the traditional power supplier out of the equation and putting more control in the hands of consumers. This technology can be used in new housing developments to work in tandem with the current electricity grid. Cellphone technology can be used so that consumers and businesses could buy the excess electricity. The ideal power system would be one that combines large power grids with clusters of small scaled power producers.
Uses of Smart contracts in the Energy industry
Smart contracts can be used to balance supply and demand
Automatically ensure that excess energy is delivered into storage
Secured record keeping for individuals and businesses to monitor consumption
Cryptocurrencies could be used to pay for the energy supplied or used
Smart contracts are a powerful modern technology that is challenging the way traditional contracts have been done. The benefits are accuracy, speed, security, trust and most of all the cost saving benefits. Organizations and individuals are still very skeptical about Smart contracts because they don’t understand the underlying technology that underpins Smart contracts i.e. Blockchain technology. With all these benefits Smart contracts they are still not accessible to all because it requires individuals with a specialized set of programming skills and knowledge to design/write a Smart contract. The other obstacle is that not every company out there accepts virtual currencies or bitcoins as payment. The development of Smart contracts could also introduce security flaws because “not all developers are created equally” – the weakest link is still a human who has to develop the code to be used in the Smart contracts.
Smart contracts have several benefits and could allow organizations to gain a competitive edge over its rivals. Each organization needs to assess their business needs and decide if Smart contracts will be beneficial for them.
CITATION 2 y l 1033 (https://bitcoinmagazine.com/articles/ripple-labs-cto-designs-smart-contracts-1406322122/) – Oracle
CITATION 1 y l 1033 (https://www.prnewswire.com/news-releases/smartrealty-brings-smart-contract-technology-to-real-estate-launches-ico-300600158.html)