June 14 by Eric Dreshfield
Smart contracts are generating a great deal of buzz. They are described as the greatest transformation of commerce since the Internet, a replacement for central banks, merchants, lawyers and many other professionals and institutions. A smart contract is an agreement that uses software methods to enforce, confirm or facilitate the execution of contract obligations. Smart contracts are sometimes referred to as “self-executing” contract because they can virtually eliminate the risk that required actions aren’t executed by one or more parties. Smart contracts are based on blockchain technology and are causing experts to rethink how legal documents are written.
What is Blockchain Technology?
Simply put, blockchains are a form of a database. The distinguishing feature is that blockchains can share control among a community instead of requiring user to rely on one central source of truth. This simple concept is implemented by cryptographic calculations that ensure the accuracy and security of the blockchain. These calculations are made by the combined computational power of the networked machines run by the blockchain community.
How does Blockchain Work to Execute a Contract?
The technical details of blockchain are complicated, but you don’t need a PhD in computer science to understand how blockchain works. Here is a short example of how a smart contract based on blockchain can function – with no math or programming required.
1. Two people, Anne and Barry, decide to enter into a simple contract using blockchain technology. Anne will complete a task, and then Barry will pay her.
2. Barry sends Anne a contract request using the blockchain, and Anne accepts it. The request defines how Anne will prove that she finished the task and the amount Barry will pay her. This amount is immediately set aside from Barry’s linked payment method.
3. The agreed contract is shared with everyone using the blockchain. There’s no central filing system: everyone in the network has an encrypted copy of the agreement. Only Barry and Anne have the correct software key to decrypt and read the agreement.
4. Anne finishes the task when she offers proof of completion. This proof could be an ERP transaction, an instruction from an Internet-connected device or something else. The blockchain verifies the proof, and payment immediately flows from Barry to Anne.
5. The completion of the contract is shared with everyone on the blockchain. This sharing keeps the network secure and accurate because everyone using the blockchain can simply compare their copy with everyone else’s. If the copies match then the record is true and complete, and no central authority is needed to verify it.
How are Blockchains used in B2B Transactions?
Blockchains are most notably used as the technology underpinning of Bitcoin, a digital currency. When applied to commercial contracts, they offer novel capabilities.
• The terms of a contract are unchangeable and executed automatically, guaranteeing events such as conditional payments.
• Contract terms, and the status of performance to terms, are fully visibly to all parties.
• No central authority is needed to clear payments or verify compliance with contract terms, reducing the cost and delay involved in commercial transactions.
• Contract execution is more durable when no longer reliant on outside parties, making contracts resistant to infrequent risks such as natural disasters, and even common events such as changes in staff
Smart contracts do not eliminate the need for legal systems and enforcement mechanisms. They offer great potential for organizations to build consensus with counterparties based on agreed standards and guarantees that each organization’s interests are preserved.