Smart contracts and their role within the corporate world Pt. 1
Enterprises encounter significant challenges and complications during the process of engaging third parties.
- Lacking trust
- Absence of transparency
- Wary and conservative action
- Intensive usage of time and money resources on middlemen in the process of agreement finalization.
Smart contracts provide the prospect of alleviating these issues by doing away with the middlemen in scenarios when contract conditions can be observed. These contracts establish trust amongst two entities by leveraging blockchain technology. They facilitate the development of immutable and accessible contracts.
Understanding the blockchain
What are the aforementioned contracts and how are they adapted to blockchain environments? To find an answer to this question, we should get into the nitty gritty of how a blockchain operates. Blockchain is based on distributed ledger technology (DLT), it is basically an immutable digital ledger on a network of users who are referred to as nodes. Every record that is documented to the ledger is unique and connected to the records prior to it. As data, which is authored with one-way encryption to upkeep a high degree of security – is transparent to each node on the network, consistently auditing swiftly identifies (and rectifies) any inconsistencies to ensure precision.
OK, but what’s a smart contract, then?
smart contract can be described as computer code that operates on blockchain and facilitates secure value exchange. They can eradicate the necessity for an intermediary when two entities desire to swap highly valued electronic or physical assets. They can be developed on platforms such as Solidify or Ethereum Virtual Machine.
They document contracts as computer code that holds the conditions of the contract. When all stipulations are fulfilled, the contract is activated.
How do they operate?
The idea underlying smart contracts can be looked at in five stages:
1] Offer: The transaction procedure begins with an offer of the first party. The first party authors its terms in the form of an “if-then” statement, then puts it onto the blockchain.
2] Negotiation: Terms are viewable to any entity on the blockchain so that two parties can negotiate on contract specifics.
3] Approval: After both entities concur with regards to terms and particulars and triggering scenarios like due date, expiration date, strike price, or other scenarios, the contract turns immutable and cannot be further modified by any entity.
4] Satisfying conditions: After each entity authorizes the contract, they can self-verify the conditions that are placed inside a contract through interpretation of real-time data.
5] Transaction: When the triggering event happens, the transferring of assets like stock, real estate, data, IP, and digital/nondigital funds take place.
More on smart-contracts in action
They operate by adhering to simple “if/when…then…” statements that are authored into code existing on a blockchain. A network of computers carries out the actions when preset conditions have been fulfilled or verified. These actions could consist of putting out funds to the relevant parties, registering a vehicle, delivering notifications, or issue of a ticket.
The blockchain then receives updates when the transaction is fulfilled. That implies the transaction cannot be modified or altered, and just the parties who have been provided permission can observe the outcomes.
Within these variants of contracts, there can exist as many conditions as mandated to satiate the agents that the activity will be finished in a relevant manner. To establish these terms, participants must decide how transactions and their data are signified on the blockchain, concur on the “if/when…then…” rules that govern those transactions, look at all potential exceptions, and provide definition to a framework for resolution of disputes.
The smart contract is then open to be coded/programmed by a developer – even though increasingly, enterprises that harness blockchain for enterprise provide templates, web interfaces, and other web utilities to streamline structuring of smart contracts.
Benefits conferred by Smart Contracts
Drawbacks of Smart Contracts
A quarter of all such contracts out there contain critical bugs. While they provide resolutions to a plethora of issues, they appear to put forth another. This is not their only drawback or limitation.
1.Tough to alter
Altering their processes is nearly impossible, any flaws within the coding can be time-intensive and costly to rectify.
2.Potential for Loopholes
Going by the theory of good faith, entities will deal fairly and not reap the advantages unethically from a contract. But, leveraging them makes it tough to ensure that the terms are fulfilled according to what was agreed upon.
Even though they look to eradicate third-party participation, it is not full feasible to eradicate them. Third parties make assumptions about differing roles from the ones they take in conventional contracts. For ex., lawyers will not be expected to draft individual contracts; but, they will be expected by devs to comprehend the terminologies to develop codes for smart contracts.
As contracts consist of provisions that are not universally understood, they are not always capable of handling terms and conditions that are vague.
Use Cases – By Application
- E-identity (DID)
E-identity is one of the forerunning use case scenarios with regards to smart contracts. A person’s identity is by far, their most prized asset. It carries with it the essence of their existence, which includes their social media presence, their reputation, perception, data, and digital assets. What blockchain does it that it drives decentralized identity. It is simple for blockchain for enterprise to drive the framework of the decentralized identity.
It not just furnishes a ready-to-go infrastructure, however, it also provides security for it. Therefore, if industry begins to harness it, it will certainly resolve the problem that is correlated with third-party companies abusing/misusing data.
DIDs have the advantage of the blockchain addresses that are responsible for making them being secured through cryptography. Another advantage of the blockchain platform for digital identity would be harnessing it as a DID registry. Essentially, all the data contained on the IDs can be recorded on the immutable ledger storage. It becomes impossible to access your ID, or for malicious actors to compromise your information.
Credential notarization is another overt advantage of blockchain platform deployed within the domain of identity, hash addresses can be allocated to data available on the digital identity blockchain platform. Hashes would serve as an electronic seal, and the issuing entity of certificates or documentations could allocate a hash which would serve as a point of reference for the end-user. This virtually eliminates the potential for falsifying paperwork and documentation.
The blockchain platform gives you full control over who you share your information and data with. Identity is central to electronic life, and blockchain can greatly facilitate trust, transparency, and accessibility.
They are expected to be widely deployed within the securities market. Private securities can be termed as financial instruments such as bonds and company stocks, however they are only purchased and traded between vetted private parties. Owing to this restriction of being offered and received by private entities, private securities usually have issues such as reduced liquidity, high settlement risks, manual asset servicing, investor’s interest locking, etc.
With the assistance of blockchain, you can resolve these issues through issuing and management of securities that are present on the blockchain. The procedure of issue of securities on the blockchain is referred to as STO (Security Token Offerings), and these securities are referred to as security tokens.
There are several advantages with regards to issuing of securities on the Blockchain.
- Primed for compliance – Regulatory authorities such as the Security Exchange Commission guard private securities within the United States of America and other regulatory entities internationally. These regulators authorize who gets to own a specific variant of private security. For instance, in the United States of America, only accredited investors can own private securities. So these compliances can be easily to fulfil leveraging security tokens that harness blockchain tech.
- Increased liquidity – As security tokens are cryptographically secured tokens that can be coded for compliance on a blockchain, they organically turn more liquid. Additionally, the addresses of these tokens can undergo verification easily via the means of an effective KYC trail existing on the blockchain and therefore investors can coordinate amongst them via an ATS (alternative trading system) or security token exchange.
- Effective Cap Table Management – Ownership data will no more be a hassle as cap table management will turn more transparent and instantly available within the blockchain.
- Global Trading – Currently if Chinese investors require to purchase or sell private securities in the United States of America, that specific investor will be needed to endure a very taxing process. To cut a long story short, we don’t indulge in trade of securities globally in the actual sense of the word. However, with blockchain-driven compliance and KYC, this taxing procedure of onboarding and collaborating amongst international investors can be made frictionless.
- Expenses reduction – Presently, without the existence of blockchain, private securities need a ton of human intervention when it comes to settlement, closing, allocation, underwriting, and compliance. This mandates a major investment in human resources in the middle/back offices of investment banks. However, currently with security tokens driven by blockchain, all this can be carried out through smart contracts.
- Instant Settlements & Scalable – Blockchains facilitate development of near-instantaneous settlement systems and consensus mechanisms which will help in an effective settlement.
- Cross-Border Payments
Trade finance can also witness a paradigm shift with the assistance of smart contracts. It can certainly help in global goods transfer and trade payment initiations with the utilization of a Letter of Credit.
Obviously, harnessing smart contracts will enhance the liquidity of the financial assets, which in turn, enhances the suppliers, purchasers, and the financial efficiencies of entities. The need of the hour is for industry standards and regulations, and for them to be enforced rigorously.