Smart Contracts: How and When to Use Them
Built on blockchain technology, smart contracts can remove friction in business processes. But their function is limited by their hardcoded instructions.
Smart contracts are written on blockchain, the technology that underpins Web3. As self-executing lines of code, smart contracts introduce a layer of precision and security into transactions. Once the conditions of a contract are met, nothing stands in the way of the contract terms being fulfilled.
Instead of apps, smart contract applications are called decentralized apps (dApps), with Ethereum being the most popular language to use. Let’s talk briefly about how they work, and then we’ll share some real-life uses for them.
How Smart Contracts Work
Nick Szabo introduced the idea of smart contracts in 1997. He described a smart contract like buying a soda from a vending machine. There are only a limited number of options available to the purchaser, and all of the possibilities are pre-programmed into the machine.
- Insert your quarters.
- Select your soda.
- The machine dispenses your soda, if it’s available.
- OR the machine returns your quarters because your option is unavailable.
- Pull out your soda and drink it.
Smart contracts are also hardcoded with pre-determined decisions. Once they’re executed, there’s no way to reverse the decision. In the same way as the vending machine, once the soda comes out, there's no way to put it back.
At every point of the fork in the decision tree, there are a limited number of choices. And once executed, there’s no going back.
What Can Smart Contracts Be Used For?
We’re going to provide a few ways that we’ve seen smart contracts used, but these examples are by no means a complete list. We believe that smart contracts can potentially be applied to many different types of industries. Anytime a transaction or paper process can be automated, smart contracts can step in as a possible way to remove extra layers of work.
Supply Chain Tracking
The memes about UPS and Amazon delivery drivers giving you updates every step of the way as your package makes its way through a route to your home are funny.
Your package is leaving the facility.
Your package is on the corner of 8th and Idaho St.
Your package is close to your front door.
Do consumers really need that many details about how their package is transported?
And yet, transparency in the supply chain could’ve saved us all some headaches over the last two years as businesses and governments could see where the breakdown was occurring. Instead, since the supply chain is run heavily on paper documents handed from one supplier to the next, data analysts couldn’t see what was happening until baby formula was missing from the grocery store shelves.
As product changes hands from suppliers to manufacturers and so on down the pipeline, the potential for human error is compounded. Manual data entry and missing paperwork, as well as transportation delays, all exist in this opaque process. Locating a shipment requires tracking down where it was last checked in.
In this instance, smart contract-based applications can stand in for paperwork processes, and product tracking can happen on a decentralized network that every stakeholder can access instantly. As a product changes hands, triggering the terms of the smart contract, stakeholders can track its progress, removing the guesswork of why a shipment hasn’t arrived on time.
Consumers are willing to pay more for products that align with their values. Companies that can verify the source of their products have an edge over competitors that can’t. Business investors that are concerned about child labor, the environmental costs of a product, and fair wages for farmers or tradesmen may also be more interested in a business that can present smart contracts that track the ethical source of a product.
For example, coffee growers overseas earn about three cents per cup of coffee that’s sold for $3.50 at an American coffee shop. Attempts to pay coffee farmers a fair wage are complicated by the way coffee is shipped, blended, and repackaged. In response, an Ethiopian company is using blockchain technology to guarantee that their farmers are ethically growing coffee beans and that the farmers are getting paid fairly.
The Trust Your Supplier network is one of the companies using blockchain in the supply chain industry. Smart contracts give eco-conscious consumers the chance to shop with their values. A smart contract that verifies that a product meets its environmentally friendly standards can effortlessly tap into a market that’s willing to pay a premium.
Four of the most heavily regulated industries—health care, financial services, life sciences, and IT—need to spend more time tracking and documenting processes to withstand audits into their companies. Businesses that deal with digital assets, health records, consumer data, or private communications are also regulated.
Larger companies have entire divisions that maintain the data and reports required to comply with whichever laws they operate under. That’s a lot of people and paper to manage regulations.
Using smart contracts to track records has the potential to cut out reams of paper and man-hours. The digital ledger can prove there was an unbroken record from source to delivery, or it can verify the chain of custody for a document. One of the beautiful benefits of smart contracts is that they can be hard-coded to fit a particular product, need, or regulation.
Besides regulations, consumers are also driving the demand for sourcing proof. More than ever, consumers want to know that their purchases match their values. They want to buy goods that are produced ethically, with fair wages to workers. And they want to guarantee that the process is environmentally friendly.
One of our Ventive clients is in the diamond industry. Customers purchasing engagement rings don’t want the specter of “blood diamonds” hanging over their magical moment. Plus, some countries (like Canada) have regulations that require companies to prove the origin of their diamonds. We built an app that tracked diamonds as they were mined, cut down, and polished. With each step in diamond processing, the company records any changes to the diamonds and verifies their authenticity.
This smart contract is a “chain of warranty” that can be presented to consumers proving that their diamond is of the highest quality, as well as ethically sourced.
The Limitation of Smart Contracts
Let’s go back to the vending machine analogy. Once you’ve put your quarter in, there are a limited number of choices you can make. You can either select a soda or change your mind and push the button to return the quarters. You can’t choose beer from a soda vending machine. You can’t ask for your change in dollar bills. You can’t buy two or three sodas at once.
Just like you can’t get a beer from a soda machine, you can’t receive something from a smart contract that’s not already included in the original code. Both parties need to be clear about the terms of the contract before it’s finalized because once the contract is coded, there’s no going back.
For smart contracts to be upheld as legally binding contracts, they need to be legally enforceable, legally eligible for electronic signatures, and follow the basic rules of contractual agreements. That is going to limit the kinds of circumstances they can be used, but overall will strengthen the case for smart contracts to be applied strategically.
We’ve seen firsthand how smart contracts can ease regulatory burdens and increase transparency for our clients. Partner with an experienced Web3 development company for your next project. Ventive makes it easy for you to apply next-gen technology in your business.