November 20 by Jesal Mehta

What Are Smart Contracts

A smart contract is an agreement that uses software methods to enforce, confirm or facilitate the execution of contract obligations. Smart contracts are sometimes described as “self-executing” contracts because they can virtually eliminate the risk that required actions aren’t executed by one or more parties. These types of contracts could greatly reduce transaction costs and risks, to such a degree that predictions of the transformation of commerce are justifiable.

Smart Contracts – an emerging trend that will change how businesses transact. The term “smart contract” has been used to describe agreements created using blockchain technology. A blockchain is a shared ledger for recording a transaction history. The best-known application of blockchain today is the bitcoin digital currency.

Blockchains are a form of database. Their special characteristic is that blockchains can share control among a community instead of requiring users 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.

You may think: Why does my company need another ledger? My bank already has a ledger with my transaction history and balance, for example.

The Benefits of Smart Contracts and Blockchain

Compared to current transaction systems, blockchain technology offers several intriguing benefits:

smart contracts
1) As a shared ledger, with identical copies held by many parties, a blockchain is highly resistant to errors, tampering and fraud.

2) Transactions can’t be altered, virtually eliminating non-compliance with a contract.

3) No central authority, such as a bank, is needed to clear transactions.

4) Parties that don’t trust each other can enter into a contract because each party trusts the compliance features of the blockchain.

5) Transaction speeds and efficiencies are increased.

It certainly seems smart to embrace these benefits—so it makes sense that blockchain-based contracts that govern business transactions should be called “smart contracts”. These contracts are often called “self-executing” agreements because, once two parties reach agreement, the terms and conditions of the contract can happen automatically without further intervention.

Smart contracts aren’t about to replace your bank—and in fact, banks and other financial organizations are at the forefront of this technology. Smart contracts based on blockchains are just emerging, yet their promise is so significant that companies should begin to prepare now.

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 a 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.

Smart Contracts Are Here Now

Many of the benefits of smart contracts can be realized with better business processes and better technology already available today. Apttus, for example, offers end-to-end Quote-to-Cash processes that increase transaction efficiency and speed. And Apttus Intelligent Contract Management enables sophisticated obligation management, so contract compliance is greatly improved.

Smart contracts do not eliminate the need for legal systems and enforcement mechanisms. They offer great potential for organizations to build consensus with counter-parties based on agreed standards and guarantees that each organization’s interests are preserved.

Blockchain-based smart contracts have the greatest potential for organizations that have large numbers of transactions with many counter-parties and that use interrelated and complex contracts. Leading companies in many industries, from power generation to consumer packaged goods, have experimented with smart contracts.

Companies have updated their business processes to make the best use of these capabilities. Once these companies are ready to use blockchain-based smart contracts, the required processes will already be in place. For these companies, blockchain will be an evolution in their business rather than a revolution.

Yet every business needs to be ready for smart contracts—because businesses that don’t use blockchain-based smart contracts will be at a real disadvantage. Now is the time to get educated on blockchain.

 

Not using Smart Contracts will soon be a detriment to your business. Are you ready? Download our whitepaper to learn more.

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