Digging deeper into the world of autonomous agreements.

Robert A. Küfner
Apr 11, 2018 · 4 min read
Photo by Aaron Burden

This is a continuation from my last article; How smart are Smart Contracts?.

How do Smart Contracts Work?

Possibly the easiest way to illustrate how a smart contract works is through a simple example. So, let’s say Alice has to deliver an item to Bob. Bob agrees to pay for the item upon delivery so that he can be assured the item is delivered in good condition. Alice would also like to be assured that she will receive payment from Bob once the item is delivered.

This presents the need for an external party to ensure conditions agreed on beforehand are met and the transaction goes through as described. This is where smart contracts come in.

Instead of Bob sending the payment to Alice before he receives the delivery, or Alice facing the possibility of Bob not paying, the two can define the terms of the exchange in a smart contract. Bob would then transfer the money for the item to a smart contract on the day Alice sends the item to him.

The smart contract will then hold the amount and act as an escrow until Bob confirms the delivery of the item as described in the contract. After delivery and confirmation, the sum paid by Bob will then be released to Alice.

Breaking Down the Process

Smart contracts can self-verify the conditions that are placed inside a contract by interpreting data. Each contract runs on a node in a network in order to guarantee the contract is executed as written. This means that the creators of the contract do not have to worry about proper enforcement or whether the contract will be executed or not.

The process is reasonably straightforward:

  • Firstly, the smart contract is written into the blockchain as a code.
  • The parties involved may remain anonymous on public ledgers; however the contact and transaction are recorded.
  • A triggering event such as a due date, expiration date, strike price or other conditions is set so that the contract is easily interpreted and automatically executed according to the terms written in the code.
  • Since the data in the code is visible on the public ledger, regulators are able to monitor activity in the market while the individual parties involved can still protect their privacy.

With self-verifying contracts, there is continuous recording of data in real-time and instant feedback. Smart contracts can automate much of the smaller processes typically associated with a legally binding contract.

Ultimately, smart contracts give people a level of autonomy, security, speed and ease of use, cost-savings, immutability, accuracy, reliability, and trust that no centralized third-party can match.

Potential Use Cases of Smart Contracts

Smart contracts are flexible because they do not simply set the conditions but can also execute the terms of the contracts. The developments around smart contracts are still relatively new with less sophisticated contracts being executed, however, significant uptake of this new technology is set to proliferate the business landscape within a few years, making it possible to execute highly complex contracts.

Some of the potential use cases for smart contracts include:

  • Digital Identity and Financial Data Recording;
  • Trade Finance, Derivatives and Securities;
  • Mortgages and Land Title Recording;
  • Supply Chain;
  • Auto Insurance;
  • Clinical Trials

Benefits of Using Smart Contracts

One of the most important features of the blockchain is that the data it holds is not stored in a centralized location and since the information is distributed among all those using it, it eliminates the need for trusted third parties when transacting. This translates to lower fees and faster transaction times for the parties involved.

With smart contracts, transactions aren’t just limited to money. Shares in stocks, property and intellectual property rights can be traded too — just to name a few. Currently, most people need the aid of a lawyer, notary, or other professional to make an exchange of goods or services. These third parties typically prepare the documents needed to effect the transaction.

With smart contracts, parties can make a transfer independent of a third-party. Smart contracts lay out the rules and the penalties associated with a particular agreement and automatically enforce the obligations attached to it. Smart contracts are ideal for the interaction of real work assets such as smart property and financial service instruments.

They involve objectively verifiable performances, bypassing centralized inefficiencies and reducing the costs of calculating sophisticated outcomes, giving rise to a whole new branch of possibilities in the world of DLT.

… now just imagine you could do all of that on IOTA’s Tangle Network. If you understand the significance of that, you’ll understand why we’re so excited about the peaq project.

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nakamo.to

Picking up where Satoshi left off.

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