Please note that a lawyer did not write this piece, and it is not intended to be legal advice. I also realize that discussing smart contracts requires a discussion around tokenization; that aspect of this technology will be addressed in a later post.
If there’s one thing all web3 developments have in common, it’s the hype and promise surrounding them. The question this must inevitably lead to is equally familiar: will or can the real thing live up to the hype? In some cases, probably ‘yes,’ in other cases, probably ‘no.’ Part of what inflates hype is a general audience's lack of understanding of the topic. My goal with this blog is to shed light on the innovative tools that will shape the future. With that in mind, I’m going to toss my hat in the ring and make a prediction that I’ll stand behind:
If you’ve taken anything away from my earlier articles, I urge you to buckle in and read on. In this article, I’ll cover what smart contracts are, how they function, and explore some use cases to highlight how transformative they will be.
So, what is a smart contract? From Investopedia:
A smart contract is a self-executing program that automates the actions required in an agreement or contract. Once completed, the transactions are trackable and irreversible.
Smart contracts permit trusted transactions and agreements to be carried out among disparate, anonymous parties without a central authority, legal system, or external enforcement mechanism.
Let me try to explain this in children’s terms:
Imagine two siblings who want to trade toys. One has an action figure, and the other has a 500-piece puzzle. But, being siblings, they’ll fight and do not trust one another to live up to the spirit of the trade. Is the action figure damaged? Are there any missing pieces from the puzzle? Picture in your mind both siblings holding out their respective trade-in, each doubtful of the other, wondering if they’ll ‘get what they paid for,’ and both knowing it will be impossible (or at the very least incredibly difficult) to reverse the trade if they aren’t happy with what they get. Imagine the smart contract as a parent or third party helping the trade along. The smart contract takes the action figure, takes the puzzle, and if all the conditions of the agreement are in place - no damage to the figure, no missing pieces from the puzzle - the contract makes the exchange, and everyone receives what they agreed to. That’s how a smart contract works.
Start: The process begins.
Agreement: The parties (sibling 1 and sibling 2) agree on the terms of the toy trade.
Smart Contract Creation: A smart contract is created and deployed on the blockchain, defining the rules and conditions for the trade (no damage to the action figure, no missing or damaged puzzle pieces).
Deposit: Siblings 1 and 2 deposit the action figure and puzzle into a box where neither have access to the other toy or their own (think of escrow).
Verification: The smart contract verifies if the action figure and puzzle deposits match the agreed-upon terms.
Error: If the verification fails (damaged or missing pieces), the process ends with an error (and each sibling receives their toy back).
Trade: If the verification succeeds, the smart contract initiates the trade, transferring the toys between the siblings based on the predefined rules.
Trade Completion: The trade is successfully executed, and the ownership of the toys is updated accordingly.
End: The process concludes. The children are happy.
Check out this video on Brittanica.com for more information
You may be thinking, ‘Great, but how does this equal ‘game-changer?’ The technicalities of these technologies are challenging to understand and fully master, but the following five traits contribute to what makes this technology revolutionary.
Automated Execution: Smart contracts are self-executing. Once agreed upon and deployed on the blockchain, they perform their specified actions automatically without the need for intermediaries, centralized control, or further prompting. Once an agreement is signed and activated, neither party can back out, break their word, or exploit the other.
Transparency: Smart contracts are stored on the blockchain, and their code and execution history are visible to all participants in the network. This transparency ensures that everyone can inspect the contract's rules, verify its behavior, and guarantee nothing has been tampered with.
Immutability: Once a smart contract is deployed on the blockchain, its code and logic cannot be altered or tampered with. The contract's rules and conditions are enforced consistently across all nodes in the blockchain network, ensuring that the contract's behavior remains predictable and reliable. This immutability provides a high level of security and eliminates the risk of fraud or manipulation.
Decentralization: Smart contracts operate on a decentralized network of nodes. Each node independently verifies and executes the contract's instructions, maintaining a consensus on the blockchain. This decentralized nature ensures that no single entity or authority controls the execution of smart contracts, making the ecosystem resilient and resistant to single points of failure, censorship, or hacking.
Interoperability: Smart contracts can interact with other smart contracts and blockchain-based applications, enabling interoperability within the ecosystem. This means that different contracts can communicate and trigger actions based on specific events or conditions, creating complex and interconnected systems of automated interactions.
Agreements and contracts of the traditional/standard variety (signed paper contracts, handshake agreements, quid pro quo of various forms, etc.) are rife with opportunities to exploit one another or violate the agreement. A client might not pay (picture Trump not paying construction crews at a hotel), or a vendor might not provide timely services or assets (think of a construction crew dragging their feet or doing poor work). A hyper-wealthy party may leverage their wealth by withholding payment, forcing the other party to pursue legal action they cannot afford or accept that they’ve been exploited. Sometimes a shady or unverified service provider will vanish with a deposit. The plethora of ways an agreement can be violated (significantly or not) goes on and doesn’t need to be listed here. The point is: a smart contract inherently eliminates virtually all of them. (Check out this article from coinmarketcap.com to learn more about smart contracts, the risks involved, and the security features that make them so durable.)
All terms, possible outcomes, and points of contention are explored, planned for, and built into the contract before execution. Assets (funds, materials, or commodities) are placed under the authority of the contract, removing the risk of either side acting in bad faith before or during the processes spelt out in the contract. By virtue of automation (not humans with emotions), there is less risk that one party will violate the agreement. If all the conditions are met, the execution of the contract is automatic and entirely executed. If a real-world obstacle obstructs a step in the contract, a contingency addressing that obstacle activates. Provided the contingency is successfully resolved, the contract continues forward. If not, the contract reaches an error, and the process concludes (in a way that the parties previously established). This guarantees the elimination of bad faith actors, non-payment upon completion of an agreed-upon service, and assurance of customer satisfaction.
As I mentioned earlier, not everything smart contracts do has to be tied to finance. Individuals and businesses can manage the payment process outside of crypto and still use smart contracts to primarily enhance the efficiency and agility of their processes through automation. Automation is available to the average person for the first time, allowing us to streamline an array of tasks and responsibilities.
(As contracts and agreements are legal documents which create binding guarantees between multiple individuals or organizations, the questions of legality and enforcement are complex and essential to explore. Some preliminary information on this can be found here.)
This article is intended to introduce smart contracts and will certainly not be my final word on the topic. For now, consideration of current and possible use cases for smart contracts should highlight their game-changing potential and impact. I’ll break this into three categories: Peer-to-peer transactions or smaller individual agreements, enterprise, and quality-of-life improvements.
Peer-to-peer transactions or smaller individual agreements
Deals and agreements between two parties - in whatever form that takes (contractor/client, vendor/customer, friend/friend, etc.) - can be streamlined and simplified to eliminate ambiguity and any opportunity for exploitation. Consider the reference from earlier to Trump and the contractors he’s worked with. By having a neutral third party (in the form of the contract) that guarantees all parties adhere to and carry out every aspect of the agreement, neither side has to be concerned about the other acting in bad faith or falling away from their commitment down the line. So, Trump is guaranteed good work, and the contractors are guaranteed to get paid.
There are countless forms and iterations of peer-to-peer transactions that smart contracts can defang, thereby truly enabling trust and peace of mind throughout the process. As the gig economy grows and more laborers become independent contractors, smart contracts offer long-needed protection and a form of recourse that enables them to operate more confidently without worrying about being hung out to dry.
Supply chain management
Smart contracts can help track and verify the movement of goods along the supply chain. They can automatically trigger actions like verifying product authenticity, updating inventory, and executing payments when certain conditions are met. This increases transparency, reduces fraud, and streamlines the supply chain process. Furthermore, recalls can be more precise; this reduces the likelihood of shortages (like the baby formula one), or the need to destroy entire fields or herds of animals in the case of food recalls.
Auditing & Compliance
Think of all the brands in your life: your car, your clothes, your shoes, the movies you watch, anything. Brands are all about IP - and protecting that IP. Any contract set with a vendor to produce and sell branded materials has many inherent challenges in ensuring compliance. There are plenty of ways that companies can leverage web3 to bolster compliance, which you can learn about here. For now, let's use Disney as an example
Disney licenses an enormous volume of IP content to other parties. So, for instance, say a manufacturer wants to print and sell Mickey Mouse t-shirts. Disney and the manufacturer agree that they can make 1,000 shirts. Not 999, not 1,001, but precisely 1,000. And Disney is very protective of their brand, so they want to ensure the placement of Mickey is precise and approved on the shirt. That the exact correct color of thread is used, that the size of the Mickey Mouse image is correct, and that the shirts themselves are the approved colors. The list of specifications goes on. Disney doesn’t inherently trust a vendor to uphold their standards, so they send a compliance auditor (or hire a consulting firm to do this) to the manufacturer and do a count and inspection. The auditor counts each shirt printed, ensuring that precisely 1,000 shirts have been produced (no more, no less), and inspects to ensure all technical specifications are accurate. It is a time, labor, and cost-intensive approach they must take with every vendor everywhere in the world. Imagine all the money that represents.
Smart contracts can handle all of this. NFTs and computer vision, prompted by the contract, perform a count and inspect each shirt for technical precision. The contract is a component of the production of the materials, meaning it is not only the repository of the agreement but is interacting with the manufacturing equipment, allowing the printer to produce the 1,000 shirts and then locking off access. Operating with the contract, computer vision inspects them all to ensure Disney’s specifications are met. This means it’s literally not possible for the vendor to violate the agreement.
Capabilities like this will enhance and simplify IP protection but won’t stop there. Implications and benefits abound in procurement, bidding/online auctioning, crowdfunding, and much more.
Quality of life improvements
Insurance claims & processes
Smart contracts can automate insurance claims by instantly verifying policy terms and conditions, assessing claims against predefined criteria, and automatically initiating claim settlements. This minimizes the need for intermediaries, reduces paperwork, and, critically, speeds up the customer claims process.
Real Estate & Vehicle Transactions
Smart contracts can facilitate the buying, selling, and renting of properties. They can automatically handle tasks such as property title transfers, payment processing, and escrow services. By removing the need for intermediaries like escrow agents, smart contracts can streamline transactions and reduce costs.
Cross-border money transfers
Crypto already does this, but you can lock in exchange rates with smart contracts. So, say you’re sending money to India, but the exchange rate the day you send the money is not the same the next day - the smart contract locks in the rate on the day the agreement was made.
Smart contracts can be used in various financial applications, such as peer-to-peer lending, crowdfunding, or asset tokenization. They enable the automatic execution of loan agreements, disbursement of funds, and repayment based on predefined conditions.
Digital Identity Verification
Smart contracts can enhance identity verification by securely storing and validating personal information on the blockchain. They enable individuals to maintain control over their digital identities and selectively share data with trusted parties such as banks, government agencies, or service providers - without a centralized identity systems.
Remember that moment in The Matrix when Neo realizes he can download new skills like kung fu and instantly transform himself? The ‘whoa’ factor of that moment? Hopefully, the ‘whoa’ factor (factors, really) of what smart contracts do and are capable of has begun to clarify:
They remove intermediaries that slow down or dilute an agreement's clarity, effectiveness, or authority. You no longer have to trust the other party - you trust the contract. Then, by virtue of being able to trust the contract, you can trust the other party because they can’t screw you over.
They provide a complete array of contingencies if real-world complications interfere with the specific terms of the agreement. This includes some deliverables being late or not up to the expected standard or that payment or resources are not delivered according to schedule. Paper contracts have a plan for different contingencies when one party or the other has a grievance - but enacting those contingencies can still be slowed, stalled, avoided, or prolonged. Do you go to court? Get a lawyer? Call the police? With smart contracts, you no longer need to worry about anything because all contingencies are programmed. Every possible outcome is planned for and detectable to the contract, and if a contingency needs to be launched, the contract immediately goes into action.
A critical feature of smart contracts is their ability to gather real-world information via an ‘oracle.’ Think of an oracle as a machine that can collect real-world data and see if and how it applies to a smart contract. For example, imagine a contractor has been hired to pave a driveway in seven days, but a heat wave makes it unsafe for workers to be out during five of those work days. Oracles review the pertinent data to confirm the external truth. In this case, the oracle would be programmed to monitor data from a source like the National Weather Service. If the temperature is above a certain level, it confirms what the contractor has said and launches a contingency (presumably adding time to the agreement). If the temperature was not too high (and the contractor was lying), the contract understands this and launches a different contingency (presumably penalizing the contractor somehow). No third party or judge is needed to advance the situation. The smart contract acknowledges that specified factors (like weather) could impact the outcome of the agreement, and both parties agreed in advance on how this will be handled. Therefore, these contingencies don’t rely on human common sense in a given moment but on data sourced from a place that both parties agree will be taken as fact. This eliminates the ambiguity that could mire a project in legal proceedings, arbitration, etc.
Smart contracts live in a world where the contract/agreement cannot be manipulated or changed by one side or the other. Imagine a person’s last will. They created and signed the document and stored it in their lawyer’s office (in a hard drive or paper file). Various relatives, friends, business partners, or associates can argue and haggle over the document's validity, finality, or veracity, triggering a slow, grinding, hostile probate process. If that same will existed as a smart contract, it would live on a blockchain that would be verifiable, immutable, and could be tied to supporting documents like a physician’s notes from a recent physical. Hopefully, this guarantees that the spirit of the will be followed. This example focuses on wills, but why not any other type of document? Consider how this could impact documents tied to expressing your wishes when incapacitated or records of ownership.
Smart contracts’ automated, automatic functionality will revolutionize business and enterprise as we know it. When we imagine technology automating human labor (like self-driving cars automating away taxi driver jobs, for example), a smart contract is the tool that makes that possible. Obviously, there are significant implications in terms of impact on job markets and specific careers, and not everyone will be glad for this innovation. Nevertheless, it will be revolutionary.
As web3 continues to get onto its feet, predictions and exaltations about these technologies promise nothing short of transforming how we run our daily lives, businesses, the utilities we rely on, and everything. After all, blockchain is already the home to thousands of companies and exchanges, and the value of all cryptocurrencies currently in circulation is already north of $800 billion. That said, blockchain remains in its infancy and crypto’s volatility makes its future uncertain. Smart contracts have so many universal applications for individuals, teams, businesses, and even nations that their adoption and prevalence are all but guaranteed. The road ahead for crypto may be uncertain, but the ascension of smart contracts is not, and I believe it will be smart contracts that pave the way to the blossoming of web3.