A contract is an enforceable agreement between parties. It is a way for us to manufacture enough trust when entering into any engagement, that the agreement made, will be kept. Contracts help us coordinate our activity. They lay down the rules of engagement and the conditions of the outcome. They enable trust between citizens. Without them, we wouldn’t have been able to coordinate our efforts toward common goals. It would require too much faith in one another as opposed to trust.
Faith in an agreement is the complete confidence, without proof, that something will happen. Contracts replace the need to have faith in one another with a game of enforceable incentives and disincentives. You can now coordinate with those who you do not trust because contracts give you certainty over the outcome of various eventualities.
The Problem with Contracts Today
Over time we have strengthened our legal frameworks and processes for ensuring that agreements are kept. However, our contracts of today remain corruptible and subject to conflicts of interest. Often, they are far too complex and filled with legal jargon, making it difficult to get a clear picture of the outcomes of an agreement.
This lack of clarity and gap for the abuse of trust requires us to depend on the honesty and capability of third parties to enforce our legal agreements. Without them, the relationship between the agreement and its enforcement is severed. This comes at a large cost to society.
This cost in some cases is out of reach for many people, limiting their ability to coordinate their efforts with others. The cost of contractual agreements can be thought of as the price of trust. The more expensive, slow and complex it is to create agreements, the fewer agreements we are going to have.
Take a second to reflect on the difference between developed and developing nations from the viewpoint of trust and contracts. The developed world has robust legal frameworks and processes for enforcement. The legal system that backs enforcement of contractual agreements has a long track record of dealing fairly.
The developing world, however, has fragile legal frameworks and untrustworthy enforcers with a track record of abuse.
What are Smart Contracts?
What if I told you, that every day we get a step closer to not having to rely on the honesty and capability of third parties and paying them for the privilege to do so. If this were to be true, it would represent a seismic shift in the way we trust one another. It would unleash collaboration between distrusting parties on a scale not previously possible.
This reality is upon us. The evolution of contracts is happening right now with smart contracts and platforms such as Ethereum. In previous articles, we have described smart contracts as basic conditional agreements. If this, then that. When this, then that. Here we will cover them in more detail:
“Smart contracts are computer programmes that can be consistently executed by a network of mutually distrusting nodes, without the arbitration of a trusted authority” — Bartoletti and Pompianu, 2017
Once a smart contract is deployed on a network it cannot be altered, stopped, or deleted unless programmed to do so. The “smart” part refers to the certainty of contract fulfilment, they make agreements between parties inseparable from execution.
They replace third parties with decentralised and cryptographically secured technology. They remove opaque regulatory relationships and instead use mathematics and computer science.
If we can, on the internet, provide people with the ability to create their own contracts, that execute without relying on layers of intermediaries, we can drastically lower the costs of reaching agreement and therefore foster low-cost collaboration.
Smart contracts might just make this a reality.
Advantages and Disadvantages
Use Cases for Smart Contracts
Each of these use cases deserves its own article. Below serves as brief examples of what smart contracts are already making possible.
Ø Insurance — Using supporting IoT devices and data one could automate insurance payments and reduce the amount of fraud that occurs.
Ø Crowdfunding — During 2017 over $18 billion was raised by initial coin offerings in order to fund the development of blockchain-related projects.
Ø Payments — Fast and cheap global payments can be made with various digital assets. All complicated clearing and settlement can be performed without a third party.
Ø Trading — We can now use decentralised exchanges and automated market makers like Uniswap. Just like payments complicated clearing and settlement can be performed without a third party.
Ø Manufacturing — Large manufactures need to trace thousands of parts/inventories spread across the globe. You will be able to have more accurate data about where they are, how long they will take to arrive and make sure that they all accounted for.
Ø Supply Chain — There are thousands of moving parts when it comes to global supply chains. You will be able to track and trace all these disparate channels. You can also automate certain functions and trigger each phase automatically.
Ø Provenance — You could embed historical metadata closely to the item to prove where it is from.
Ø Voting — Using the blockchain for its immutable nature to gather, store and trigger actions corresponding to the result.
Ø Internet of Things — As the use of IoT technologies increase we can use it for things like connecting computer to computer and tracking data which will help automate reactions or processes further.
Ø Royalty Distributions — We can automate the payout of royalties to authors, musicians, and other content contributors.
Ø Public Sector Data — We can keep personal data of citizens secure and make it more trusted across the globe.
Whilst we all have the option to look, to seek to understand, it’s often easier not to. Bitcoin, Ethereum and distributed ledger technology are complex systems that require significant due diligence. At Etherbridge we aim to lower the barriers of understanding this fast-growing digital economy.
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This is not financial advice. All opinions expressed here are our own. We encourage investors to do their own research before making any investments.