Smart Contracts
This article is part five in our five-part series about blockchain technology:
If this then that. This is the simple boolean premise on which is built the logical structures of our lives.
If you swipe your credit card at the pump, then you can have gasoline for your vehicle.
If you remit your final mortgage payment to the bank, then they will hand you the title to your home.
If a highway patrol officer catches you cruising above the legal speed limit, then you will have to pay a fine.
If you have read our previous articles in this series about blockchain technology, then you likely know where we are headed in this one.
Blockchains are excellent vehicles for establishing digital trust and removing intermediaries from transactions which is why the big players, like Blockchain, focus only on financial transactions: I send you Bitcoin through the chain and the transaction is forever encrypted into the history of that chain so that I can’t spend that money twice. Moreover, an intermediate bank is not needed to process the transaction since the Blockchain also documents (instantly) that the Bitcoin I have sent you now belongs to you and you alone.
The trust we have in blockchains is derived from the fact that they are decentralized, with thousands or tens of thousands of unrelated entities reaching a consensus and agreeing on the historical record with each and every transaction we make. With such a powerful mechanism in place for establishing trust, managing financial transfers, and memorializing historical accounts, couldn’t blockchains handle more than mere financial transactions? The answer, of course, is a resounding “yes”.
Nick Szabo
A decade before a person (or persons) writing under the pseudonym “Satoshi Nakamoto” published the seminal treatise “Bitcoin: A Peer-to-Peer Electronic Cash System”, another thought-leader had begun to make noise about the potential for creating self-executing contracts.
That thought leader is Nick Szabo, an American computer scientist and legal scholar who proposed a system of converting contracts to code that could be distributed to an encrypted blockchain and self-execute when all conditions of the contract were satisfied: If you pay for your home in full, then the title as automatically assigned to you. If you do not pay for your home in full, then your interest is compounded and you must continue to make your mortgage payment each month. If you stop paying for your home altogether, then legal proceedings to repossess the home will begin automatically.
This sounds pretty great; in theory, it would even allow for a collective of the blockchain’s participants to crowd-fund the purchase of your home by putting in place a smart contract that guarantees you will pay off the balance at a given interest rate over time with the proportional returns going to each of the blockchain’s participants that helped you make the purchase. When the balance is paid off, the title goes to you. Before that time, the title to your home exists in the blockchain but belongs to no single entity. No banks involved.
However, Mr. Szabo’s idea was a little ahead of its time and it would be almost twenty years before his vision could become a reality.
Ethereum
Ethereum is an open-source blockchain protocol first proposed by Vitalik Buterin in 2013. Riding on a wave of blockchain enthusiasm created by Bitcoin, Ethereum is widely seen as the next evolution of blockchain technology as it not only allows for financial transactions but for smart contracts as well.
Under Ethereum’s protocol, smart contracts can be written into the blockchain using specific programming languages to encode the contracts with boolean logic. Time limits can be set on the contracts so that if all conditions are not met by a given date, any pending financial transfers go back to the original parties. This is very similar to the escrow services with which we are all familiar but remember, with blockchain technology, there are no third parties. The blockchain hosts and evaluates the conditions of the contract autonomously to execute the prescribed outcomes.
Transaction fees for execution of smart contracts on Ethereum come in the form of “gas” expenditure which is tied to the size (in storage space) of the contract and not to increase profit for a third party. This is necessary to create a strong disincentive to spam the blockchain with large unwieldy contracts and it also has the effect of keeping real monetary value, originally from fiat currencies, flowing into the blockchain thereby increasing the real-world value of Ethereum’s currency, the Ether.
Practicalities
While smart contracts sound great in theory, their efficacy depends on the participation of all parties, including those who must digitize value-backed items such as deeds and titles. At the time of this writing, it is not clear how that will be done and the onus seems to be on the authorities that currently control these items–banks, governments–to lead the way. The problem is that the disintermediate nature of blockchain is at odds with banks who seek profit and governments who seek to regulate.
This is not to say that smart contracts are not feasible. It is simply important to note that the use of them will require more than the digitization of contracts and transfer of monetary value.
Enterprise Use Cases
In our view, the most present and interesting use case for smart contracts is those concerned with eCommerce of digital assets.
Consider pop music: barring any contractual obligations to a record label, a chart-topping recording artist could release a new album as a smart contract. With each purchase of the album on a blockchain such as Ethereum, the purchase price can automatically be distributed among the recording artist, the songwriters, the producer, and so forth. Want to use a song from the album in your commercial? Smart contracts could handle royalties, settle payment, and distribute the necessary licensing. The key here is that there is no central third party needed for any of this to happen. The record labels probably are less thrilled about this than we are!
Content creators in general will benefit from smart contracts. It is no secret that authors are increasingly becoming disillusioned with large distribution channels such as Amazon that, according to the authors, attempt to depress the price of their product via threats of limiting pre-release sales or even physical delivery. Polyrific has no official opinion on that debate, but regardless of who is right or wrong, content creators of all types can instead turn to a public blockchain as a means of distributing their content and handling the financial distributions for each transaction.
Smart contracts are not just for major purchases and complex royalty distributions. Imagine you are a major electronics company such as Samsung that is offering a $20 rebate on each new smartphone sold if the customer completes an online survey. In this situation, a smart contract can be created with each purchase and automatically credit the user their rebate once they have completed the online survey. No third parties would be necessary–no payment processors, no clearing houses to process written requests for rebates, nada.
Wrapping up
Our goal in writing this article is not to tell you everything that you can do with smart contracts–we don’t have that answer ourselves–but instead to spark your own ideas of how you might use the technology.
As you go on that journey of innovation for your own enterprise, we’d be grateful if we could join you. Please reach out via email to let us know how we can help.