In recent years, there’s been considerable talk of blockchain and its use cases in the business world. While some of these topics have specific use cases – metaverse, decentralized finance, etc – there is one topic that underpins everything in the blockchain and decentralized space: smart contracts. Smart contracts are behind-the-scenes applications that route data, track changes and settle transactions in a trustless manner.
This is the first in a three-part series of blogs focused on smart contracts. Today, I explore the concept of smart contracts and their overall role in the blockchain and digital asset space. Parts two and three will focus on smart contracts design, standards and why securing smart contracts involves a shift to the left.
First, what are smart contracts?
Simply put, smart contracts are applications that codify business logic, enabling automatic execution of the applications according to the design of the contracts. Smart contracts can be applications designed as single contracts or as many contracts to comprise a decentralized application (dApp).
These applications are ultimately published to a blockchain, where they can be called by any user on that network, provided they meet the requirements to execute the functionality they are attempting to call.
While not the primary focus of this blog, there are a wide array of legal issues triggered using smart contracts, and a host of structural legal frameworks needed to accommodate some of the unique aspects of these mechanisms. One of the building blocks likely to support smart contracts will be the adoption of Uniform Commercial Code Article 12 (the controllable electronic record), winding its way through state approvals. Among the list of potential legal challenges sure to be the subject of lawsuits in regulatory action are the following:
- Traditional measures of contracting (offer, acceptance, consideration, etc.)
- Data privacy issues (including perpetual retention of personal data)
- Anti-money laundering and Know Your Customer (KYC) rules
- Intellectual property considerations
- Liability and enforcement
- Jurisdictional issues
- Dispute resolution
The law will likely do what it normally does with new technologies – try to catch up as quickly as possible.
How do they work? What is the process?
The goal of a smart contract is to have a trustless execution layer. This is possible because once deployed, smart contracts essentially serve as a self-executing layer for agreements between parties, which can run without the need for intermediaries. Once the business logic is coded, compiled, and deployed, the contract handles enforcement of transactions and related state changes. Maintenance of the dApp for this layer is not required by the organization or individual who deployed the contract. Once deployed, as long as the supporting network (i.e., Ethereum) continues to operate, the contract will remain live and on-chain forever, remaining functional as permitted by the rules and logic encoded in the contract itself.
Why use smart contracts?
Smart contracts have many different potential applications across a variety of industries. Potential use cases include:
- Asset tokenization: Tokenizing real-world assets like real estate deeds, car titles and other assets making them more accessible and transferrable on blockchain platforms/public decentralized ledgers.
- Automated compliance and reporting: Smart contracts can be designed to automatically enforce regulatory compliance requirements, potentially reducing administrative costs while strengthening reporting accuracy.
- Cross-border payments and remittance: Organizations can leverage smart contracts to facilitate faster, more cost-effective cross-border transactions.
- Supply chain management: Replace existing manual processes with a transparent end-to-end chain of custody that enables better traceability and provenance and builds stronger consumer trust.
- Decentralized finance (DeFi): Finally, smart contracts enable the creation of decentralized financial services and applications. These decentralized platforms can include lending, borrowing, and decentralized exchanges, without the need for traditional intermediaries.
As one can imagine, many other applications and transaction models can be built on a decentralized network. the potential uses span many industries including real estate, healthcare, supply chain management, government records and more. This is the beginning of a new era, bringing potential to the digital asset creation and management space.
The next post in this series evaluates contract design and standards in greater detail, providing valuable insights and guidance for developers and users alike. Stay tuned for more information on smart contracts and security in the blockchain and digital asset space.