Smart contracts use the blockchain, the technology that powers crypto, to generate self-enforcing and digitally distributed contracts. They can execute themselves automatically when certain conditions are met and are difficult to manipulate or spoof, preventing fraud.
These smart contracts may be perfect for startups and other newer, less-established companies — especially when they’re creating business relationships where trust between parties is essential. Smart contract use cases include mortgages, supply chain contracts and identity management.
What are smart contracts on the blockchain?
Smart contracts run when certain predetermined conditions are met. In most cases, they’re used to automate an agreement so each party can be sure of its outcome without conferring or agreeing that circumstances have been fulfilled.
The contracts can also help automate workflow and trigger actions in certain situations.
Contract information is stored on the blockchain, a digitally distributed ledger technology that makes it almost impossible to alter existing records. This ensures that the terms of the agreement are recorded and executed accurately. The rules of a contract can be embedded directly into the blockchain.
How do smart contracts work?
At their most basic, smart contracts are a series of “if-then” statements that outline a series of conditions and actions that will be taken. Some may also use “when-then” statements that are triggered on a certain date or once some amount of time has elapsed.
These statements are written into code on the blockchain. A network of computers determines when the contract conditions can take effect and trigger the actions, which could involve disbursing funds, or releasing or sending notifications to other programs. When this happens, the network updates the blockchain to mark the contract as having been fulfilled.
Because the contract is stored on the blockchain, which is designed to be only updated, it is extremely difficult for anyone to alter it once it’s in place. The code and status of a smart contract can be encrypted, meaning that only parties with the correct permissions or access can see the result of the agreement after it has been executed.
Smart contracts are usually either programmed by a hired developer or generated using a preexisting tool or template that another organization has provided.
These templates tick all the essential legal checkboxes small businesses and freelancers need to keep track of. They make it possible for startups to create smart contracts of their own without directly working with a blockchain developer.
Why use smart contracts?
Businesses primarily use smart contracts when it’s not possible to fully trust a party they want to work with. Sometimes a company wants to simplify some part of the contract creation process.
One advantage of smart contracts is identity verification. Information inaccessibility, insecurity and fraud can make trusting individuals and organizations risky.
Blockchain-based identity management systems can help organizations overcome some of these challenges. For example, parties to a contract can sign up with the same self-sovereign identity (SSI) and data platform. In doing so, they will receive a pseudo-anonymous decentralized identifier (DID), along with an associated public and private key.
The DID can serve to verify identity tied to certain information and access to services. Each party can use it to prove their identity when using other methods of trust verification wouldn’t be practical or possible.
These features, and the smart contract model in general, build trust between parties and ensure everyone is whom they claim to be.
Smart contracts can also guarantee that both parties uphold their end of the bargain. For example, many businesses take steps to protect themselves from nonpaying clients — smart contracts are another tool they can use to enforce this.
Use-cases for smart contracts
Smart contracts typically work best for agreements with terms and actions that can be easily represented in straightforward computer logic.
For example, a travel insurer and startup could program a contract that automatically pays out when certain flight numbers stored in the blockchain are canceled.
In other cases, smart contracts could help insurers resolve disputes and reduce claims fraud. For example, nondisclosure agreements are a popular legal tool for businesses that need to keep sensitive information confidential, like trade secrets.
Companies can embed relevant documents and information directly in the blockchain — connecting this information to the nondisclosure agreement (NDA) while also encrypting it and ensuring that only appropriate parties can access it. Some businesses already offer online web tools that allow organizations or individuals to create smart NDAs, helping them protect intellectual property, trade secrets and other valuable information.
It may be possible to use smart contracts for automating business compliance, documentation and loan payment in the future. For example, a business could generate a uniform commercial code (UCC) lien contract that automatically renews, releases, or calls for collateral. They could also automatically delete records that must be destroyed after a predetermined sunset date.
How startups can benefit from smart contracts
New companies, like startups, can sometimes struggle to lay the foundation for strong business relationships. Suppliers, insurers, and other essential partners may prefer to work with established businesses with known track records.
Smart contracts can mitigate some of the risks associated with a new business helping startups form the partnerships they need. With a smart contract in place, all parties know that certain actions will be taken automatically when conditions are fulfilled.
This guarantee means businesses partnering with a startup or other new company won’t have to worry as much about the contract falling through. The blockchain will guarantee that the executed agreement will be enforced.
Smart contracts can improve trust between business partners
Startups and other businesses can use the blockchain to more effectively negotiate agreements when not all parties trust each other. Storing information this way makes it possible to automatically execute contracts and technology like decentralized identifiers. These technologies ensure that all parties are whom they claim to be and that agreements will be followed through at the right time.