Smart Contract Basics

Blockchain innovations offer the potential to change how business is done in industries and governments all over the world by offering a fast, decentralized, and secure means of conducting transactions. One area where blockchain technology is already starting to change how things are done is contracts. Using the blockchain for contracts, otherwise known as smart contracts, is an exciting development that also presents some potential pitfalls.

Simply put, a smart contract is a contract put into code and set to check against the status of the contract’s terms and conditions in order to verify and execute it. The data used to verify that a smart contract’s terms are met are pulled from outside sources and are verified by the network. Smart contracts are able to self-execute when the terms of the contract are met; for example, if a payment is contingent upon the contract’s terms being met, once the data has been verified and the terms met, the smart contract can release the payment data to the payee.

Smart contract offer a number of advantages over the pen-and-paper or digital alternatives. As with everything operating on a blockchain network, it removes the intermediary, simplifying the process and removing what could be costly transactional fees, including attorney costs, and the reliance on a third party to enforce the agreement. Smart contracts also avoid issues of security that come with centralized storage of a PDF or paper contract, with the attendant possibilities of data corruption or hacking or simply losing a piece of paper; the blockchain is nearly impossible to hack, and your data is stored across the network. And blockchain transactions are exponentially faster and easier to complete than trying to work with an attorney or other agent.

While smart contracts do have their advantages, there are issues that the process can present. Smart contracts work on an absolute if/then protocol that is binary. But contracts exist between people, not machines. Often the language in a contract as drafted by an attorney is intentionally ambiguous to give both parties desired flexibility, and things like ambiguity or intent can’t be interpreted can’t be interpreted by a program. And extenuating circumstances or “acts of God” can come into play in any number of ways that can impact how a contract is carried out; once a smart contract is set up, it is almost impossible to stop or undo, regardless of the reasons.

While smart contracts may not be perfect, they represent an exciting step forward for the potential of legal agreements to be faster, easier, and automated for the countless entities that rely on contracts on an everyday basis.