What are Smart Contracts?

I was introduced to Smart Contract technology in 2018, and despite me being in the financial sector for over ten years, I was nodding away without realising the true potential of Smart Contracts (SCs). It wasn’t until I went through the initiation process of working on a project with an International Bank attempting to apply Distributed Ledger Technology (DLT) such as Blockchain to a number of financial services when things started to sink in. 

Initially SCs were explained to me to be like a Crowd Funding site, you have:

1. A project
2. A target funding requirement and
3. Donors who provide monies on the premise that the money will be returned back to them should the targeted funds not reach

The Crowdfunding organisation sends the funds to the project if/when target has been reached. If the target has not been reached the monies are returned back to the donors. The role of the Crowdfunding organisation can be carried out by a Smart Contract.

That explanation was a SC in its simplest form, what I did not realise is how this concept opened SC technology when used in conjunction with DLT such as blockchain, however just by the above example alone, you can imagine the possibilities that end-users (customers) can have in relation to minimising:

1. Cost and efficiency (no more service charges and you are in direct control typically 0.01% as opposed to typical charges of <10%)
2. Time in processing (transparency throughout as it is distributed for all to see)
3. Error and fraud (audit trial, once a SC has been put in place it is immutable)
4. Information breaches (privacy controls)

Computer scientist, Nick Szabo described SCs as “a set of promises, specified in digital form, including protocols within which the parties perform on these promises” simple enough as any other paper contract, but SCs are tamperproof and protected by cryptographic methods. 

Imagine a Will that is set in a SC on a distributed ledger, there are no executors, trustees are informed in real-time and as soon as the testator dies the SC acts as an executor and provides all control to the stated assets to the beneficiary as soon as the death has been confirmed. The SC is self-executing (without human involvement) and immutable (cannot be altered), it can be either set up as permissioned (where Trustees have to provide their agreement prior to execution) or permisionless. Imagine a futures contract without paying a broker, a loan without a decision-making process, selling your house without an estate agent or solicitor, this technology changes how we have been programmed to do things previously. 

If you have not spent time researching this technology then I would strongly urge you to spend some time to understand the true potential of DLT and SCs alone as I truly believe this is as big as the internet was back in the early 90s, the world as we know it will change. 

On a high-level, SCs with DLT go through four stages:

1.     Agreed parties code the terms of the agreement in a SC

2.     They validate the contract and record it to a distributed ledger

3.     The SC connects to relevant external data feeds or systems

4.     The SC either executes or expires based on the terms of the agreement

Banks are testing / using SCs through DLT for loans, trade finance, credit default swaps and securities as well as a whole realm of financial products. When I was working on a project two years ago testing a proof of concept, we tested a cross-border payment which typically took two days via the old banking system as the following diagram shows:

There are typically four banks involved when a cross border payment is made, each back has to carry out verification processes such as:

1. Name & Address (ID)
2. Verification
3. Source of funds
4. Screening - Sanctions, PEPs and negative media searches

You can appreciate the room for error, opportunities for fraud, delay due to clarification lapses etc. This is why it typically takes two days.

When a cross border payment was carried out using the Ripple platform, the whole process took less than 10 seconds, that was with the above checks taking place.

Within the above example, the technology is used but still going via a third party (the bank), you can now ask yourself the question, ‘do I need a third party if the smart contract is carrying out all the checks and protocols for me?’ that depends on how much you trust the technology and how much you trust yourself being in charge of your own transactions.

Whether you’re an early adopter or a late developer, this technology is being used and is gaining popularity (as well as trust) every day. If you’re still sceptical, I would urge you to at least carry out your own research on this technology and then make up your mind, because you don’t want to be scratching your head in the very near future wondering what happened.

Although I have been introduced to this technology two years ago, I still classify myself as a neophyte and constantly looking into this, every time I look into it I find out something new, it is like a new world that you have to explore. It is Tomorrows World.