Today, smart contracts are available to optimise many financial and business processes. In essence, they are self-executing, self-enforcing protocols that are governed by explicit terms and conditions.
On blockchain, smart contracts can streamline complex processes (link resides outside ibm.com) that involve several intermediaries and this has led to them becoming one of the most popular and talked about subjects in the blockchain industry. They allow the performance of dependable transactions without the engagement of third parties.
Smart contracts represent a completely different way of approaching contracts. Instead of two parties signing duplicate copies of a paper agreement, smart contracts ensure compliance (link resides outside ibm.com) through blockchain technology. This reduces costs and simplifies the contract negotiation process.
A smart contract works through an executable code (link resides outside ibm.com) that runs on top of the blockchain to facilitate and enforce an agreement between untrusted parties without the involvement of a trusted third party. This code defines the mechanisms of the transaction and is the final arbiter of the terms. The readable terms of a contract are compiled into computer code that can run on a network.
A network of computers executes the actions once predetermined conditions have been met and verified. The blockchain is then updated when the transaction is completed. Once the transaction is included in a block, the smart contract is initiated and irrevocable.
Transactions between parties in current systems occur in a centralised form, however, this involves high transaction fees and security concerns. Smart contracts remove the need for intermediaries and contract enforcement.
Smart contracts can bring radical transformation to industries like finance, real estate, retail supply chain, telecom or manufacturing by changing the way international business and trade is executed. They improve the efficiency and speed with which commercial arrangements are carried out and facilitate complete transactional transparency. Other benefits include improved security as all actions are recorded.
With blockchain, the goal of a smart contract is to carry out a set of instructions that end up simplifying business and trade between anonymous parties. Blockchain is a distributed database that records all transactions that have ever occurred in a network. By scaling down the formality and costs associated with traditional methods, smart contracts have become a foundational technology in blockchain and a key element of the Ethereum network.
Ethereum is the most common blockchain platform used for coding and proceeding smart contracts since its language supports the Turing-completeness feature which facilitates the creation of more advanced and customised contracts. This open-source platform has one of the largest networks of developers available. However, there are a number of other different platforms which provide similar results such as Aeternity (link resides outside ibm.com), Cardano (link resides outside ibm.com) or Qtum (link resides outside ibm.com).
Blockchain is the perfect environment for smart contracts as the data can never be lost, modified or deleted. Further to this, Gartner predicts that organisations using blockchain smart contracts — whether externally imposed or voluntarily adopted — can increase overall data quality by 50% (link resides outside ibm.com).
Smart contracts can be bundled into decentralised applications within decentralised finance (DeFi) to execute more complex functions. The validity of smart contracts in financial technology (FinTech) is becoming more and more apparent (link resides outside ibm.com). This new form of agreement improves the accuracy and verification of worldwide transactions by combining two simple concepts into one powerful idea.
The most widespread use of smart contracts remains in the financial industry since they solve the issue of trust in conditional transactions. Payment processing, clearing/settlement of financial instruments, trade finance, as well as regulatory technology all benefit greatly from smart contracts.
Already, with fintech giants like PayPal already tapping (link resides outside ibm.com) into cryptocurrencies, we may see digital finance companies transform into something new. This can make for a potentially smart investment to consider as we may be witnessing a new generation of finance coming to light. It has been reported (link resides outside ibm.com) that PayPal plans on launching a crypto ‘Super App’, which is experimenting with smart contracts and testing blockchains to help improve payments and other transactions.
Without compromising on credibility, smart contracts offer transparency within FinTech. By decentralising the verification of contract terms, contractual partners are more liable towards one another.
With increased transparency, platforms like WeBull or Robinhood dominate the FinTech landscape by offering access to investments that had seemed otherwise inaccessible before. However, in light of the Robinhood debacle (link resides outside ibm.com), retail investors are opting for alternative platforms offering similar features. For example, Nasdaq-listed Freedom Holding Corp. (FRHC) has a platform that enables retail investors to purchase stocks and participate in selected IPOs — albeit at a financial threshold of at least $2,000 when it comes to IPOs. Some retail investors are turning to more traditional platforms such as TD Ameritrade, E*TRADE and Fidelity. All of these offer similar features to that of Robinhood or WeBull — only with minor differences and USPs.
Smart contracts automatically execute transactions following predetermined rules thus transactions are encrypted and stored on a distributed ledger intended to be immutable.
This has clear potential for remaking the world of financial contracts. Individuals can rest assured knowing that information has not been altered with for personal benefit.
Blockchain transaction records are encrypted so security features can be integrated into a smart contract to automatically generate backups and duplicates in the event of damages, data losses to the original one or hacks. Because each individual record is connected to previous records on a distributed ledger, the whole chain would need to be altered to change a single record.
There’s also a degree of certainty involved as smart contracts execute automatically so there is no need to spend time processing paperwork or correcting errors that are manually written in the documents. Smart contracts can be executed in minutes, for a fraction of the cost.
Automating the flow of digital assets and payments can foster new products and business models within FinTech. Blockchain smart contracts decrease monitoring and enforcement costs, meaning that financial institutions do not need to rely so heavily on post-trade financial market infrastructures.
Overall, blockchain smart contracts certainly have the power to transform the way agreements are made across various industries, particularly within FinTech. However, it will take some time and require more development before it reaches its mainstream approach.
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