A contract is an agreement between two parties defining the agreement terms and legally obligating both to transact an exchange of goods or services for payment. Typically, such contracts are prepared with the assistance of an attorney or other legal representation. Modifications to contracts also require the services of an attorney and in case of a breach of a contract, arbitrators and courts get involved.
A smart contract provides the benefits of a traditional contract using technology that helps two parties exchange goods, property or services for payment, but without needing the services of an intermediary or an attorney.
Smart contracts are digital computer code written in a blockchain with rules defining the terms of an agreement, while verifying the transaction and executing the contract if predetermined terms and conditions are met. All of this is done in a transparent, streamlined manner allowing the parties to transact directly with each other without conflict or the need for intermediaries. Since a smart contract is stored on a blockchain, they are automatically trackable, immutable and distributed by nature, and hold each party responsible for their role.
The primary benefits of utilizing smart contracts in lieu of traditional contracts are:
- Speed and Savings: Smart contracts can be executed faster and at lower cost without the need to rely on brokers or intermediaries. They are automated, accurate, and save time and money.
- Security and Trust: Smart contracts inherit the properties of residing on a blockchain. Hence, they can be trusted given their immutable nature, which eliminates the possibility of any alteration to the contract. The smart contract is transparent and accessible within the blockchain, while also offering a reliable backup due to its distributed storage.
A simple example from IBM demonstrates the benefits of a smart contract. If you’ve ever leased or purchased a car, you are familiar with the paperwork that it entails. In most cases, a bank is also involved with the financing, which requires a credit check and verification of your identity, personal information and financial history. Throughout the entire process, you will deal with the car salesperson, finance broker and primary lender. Various commissions and fees are added to the car’s base price to compensate these intermediaries.
Smart contracts can streamline this complex process involving several intermediaries in the transaction. With your identity stored on a blockchain, lenders can quickly confirm your credit rating and financing capability. A smart contract could then be created among your bank, the car dealer and the lender, so that once the funds have been released to the dealer, the lender will hold the car’s title and repayment will be initiated based on the agreed terms. The transfer of ownership would be automatic as the transaction is recorded to a blockchain, shared among the participants, and checked at any time.