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What Are Smart Contracts?


Blockchain technology made its debut with Bitcoin, however, the technology has more to offer than acting as a digital ledger for cryptocurrency. A blockchain is akin to a large database that can store data and transaction records. Instead of using a third-party intermediary to record the information (such as a bank) on a centralized database, a blockchain is decentralized allowing users to validate the transactions. This peer-to-peer system gives all users access to the records and fifty percent of users must confirm whether a transaction or record is valid for it to be approved. This creates a secure and transparent network.

Blockchain technology can also be used for smart contracts. Smart contracts are contracts between at least two parties, which are written in computer code and stored and operated on a blockchain. Smart contracts “automatically verify, execute and enforce the contract based on the terms written in the code.”[1] For instance, upon the happening of an event or specific time, the contract would self-execute. Once all the conditions in the code are met the provisions will be automatically enforced.  For now, smart contracts can be used “to exchange anything of value”[2] and for payments between users. As blockchain technology removes the need for banks to act as intermediaries to record transactions, smart contracts remove the need for lawyers or courts to execute the agreement. Lawyers will however be necessary in drafting the terms of the agreement and ensuring their client’s interests are protected.

Is there a risk in creating decentralized digital contracts? The way blockchain technology is engineered limits the risks of fraud and non-compliance. As discussed previously, users need to validate every transaction, which removes the risk of a user changing the terms of a contract. Each new entry entered into a blockchain is timestamped, which prevents tampering with previous entries. Both parties to the contract can see when payment was made, therefore neither party can dispute the payment. Once a smart contract is created and stored on a blockchain, users can make amendments and revisions. This works similarly to track-changes in Microsoft Word as changes are recorded and older versions are preserved. “It not only gives a more accurate outline of the processes that took place but it makes all parties involved more honest about the transactions taking place because the ledger can’t be altered.”[3]

Will smart contracts be the future for businesses? Various companies and banks are utilizing blockchain technology. Ethereum has become a popular fintech investment because unlike Bitcoin, Ethereum is a blockchain that provides users with a platform to create smart contracts and acts as a digital wallet for their coin Ether. Companies have used smart contracts for product warranties, to timestamp and certify documents and potential discovery or evidence, contracts between record-labels and musicians, and microfinancing to start-up businesses.

[1] Gates, Mark. (2017) “Chapter Eight: Ethereum, Smart Contracts and Decentralized Applications.” Blockchain: Ultimate Guide to Understanding Blockchian, Bitcoin, Cryptocurencies, Smart Contracts and the Future of Money.

[2] Id.

[3] Id.

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