Ether Explained – Chapter 8: Smart Contracts on the Ethereum Platform

Smart Contracts are self-executing contracts that come into force at certain events and are based on computer protocols. The code and the contained agreements exist via a decentralized blockchain network. These smart contracts allow trusted transactions and agreements to be executed between anonymous parties and without a third party. And legal security should still be guaranteed. At the same time, they enable the automatic execution of contracts under certain conditions. Smart Contracts make all transactions traceable, transparent and irreversible. They are comparable to conventional contracts, such as those concluded when buying a car or an employment contract. However, they are cheaper and more efficient. Human error sources are almost eliminated. Ethereum is the best-known blockchain platform that offers Smart Contracts.

How Smart Contracts work using blockchain technology

Smart Contracts automatically execute transactions and other specific actions within a network with parties who do not necessarily trust each other. The conditions to which both parties must adhere are pre-programmed in the contract. Thereby there is the principle: "Code is law". Upon conclusion of these conditions, a transaction or other specific action is initiated. Smart Contracts are processed exactly as they were programmed, i.e. without censorship, downtime, fraud or interference from third parties being possible. At the same time, all contractual partners are informed of status changes in real time, because the decentralized blockchain architecture means that everyone must have the latest information at their disposal so that it remains secure.

Smart Contracts could considerably facilitate a complete sales process (e.g. a house sale). These contracts solve the problem of trust because they function according to the "if-then" principle, i.e. ownership of the house is not transferred to the buyer until the agreed amount of money has been transferred to the system. This means that both the money and the right of ownership are stored in the system and allocated to the parties involved at exactly the same time. In addition, the transaction is verified by the network to ensure error-free delivery. Since the problem of trust between the parties has been solved, there is no need for an intermediary: All tasks performed by a real estate agent can be pre-programmed in a Smart Contract, while both the seller and the buyer save considerable amounts of funds.

Advantages of Smart Contracts

- Trust - Smart Contracts can involve multiple parties who do not trust each other completely. This is because the fulfillment and monitoring of contracts is completely automatic. The unbiased system of intelligent contracts therefore makes trust unnecessary.

- Autonomy - Smart Contracts eliminate the need for a third party such as lawyers, attorneys, real estate agents and notaries: Contracts are monitored and adhered to without human interaction or manual intervention. If an employee is absent, delays can occur in the company or at the customer's site. When Smart Contracts are used, this problem does not arise at all because they enormously reduce the operational risk of the contracting parties. The rights of the contracting parties can be enforced automatically. Thus, for example, the bailiff's profession is at risk: if a customer does not pay the rate for his car, access to the vehicle can be automatically blocked.

- Costs and time - Since intermediaries are no longer needed, the usually high fees they charge are eliminated. In addition, Smart Contracts can save a lot of time normally spent manually processing paper documents, sending them or transporting them to specific locations.

- Security - Smart Contracts are protected from hackers by complex cryptographic encryption: No one can steal or lose documents because they are stored encrypted in a secure, decentralized ledger. In addition, no one can subsequently change the negotiated terms of the contract. Furthermore, Smart Contracts are very reliable, because with correct programming, interpretation difficulties of the contract conditions are nearly impossible.

- Means of payment - It is possible to implement crypto currencies as means of payment in Smart Contracts. This means that contract fulfillment can be paid directly in a crypto currency such as Ether.

Disadvantages possible

- Programming errors - Smart Contracts are an extremely young technology and therefore not yet fully developed. For example, the program code could be faulty. Since information on a blockchain is unchangeable, such errors cannot be corrected afterwards. Due to a programming error in a complex smart contract in the form of a "DAO", hackers were able to steal USD 50 million worth of Ether in June 2016. As a result, a hard fork was carried out, resulting in the crypto currency Ethereum Classic.

- Novel technology - The novelty of the technology raises many questions. How are smart contracts regulated by the government? How are they taxed? What happens if the smart contract does not have access to the subject of the contract or something unexpected happens? (If this happens with a classic contract, it can be revoked in court.) Nevertheless, the technology has great potential and will certainly be optimized over time.

- Unchangeability - In contrast to desktop or web applications, continuous updates of Smart Contracts are not easily done. This means that a Smart Contract code can no longer be easily revised without questioning the integrity of the data stored in the blockchain. However, the conditions for the performance of the contract may change by coincidence. It is also possible to program backdoors into the program code. The reliability and immutability of a Smart Contract based on a blockchain thus depends on its programmers. If they have bad intentions, they could send spam through a harmful smart contract or act as bots within the blockchain.

Application possibilities of Smart Contracts

Smart Contracts make sense wherever contracts need to be concluded quickly and without human or business obstacles.

- Financial sector - Since Smart Contracts were created in the context of crypto currencies, they are still predominantly used in the financial sector. For example, they focus on international payment transactions in order to make transfers faster and more cost-effective. In addition, the processing of securities transactions is seen as a promising field of application. The issue of bonds has also been initiated using blockchain technology: Together with the World Bank, Australia's largest bank, the Commonwealth Bank of Australia, has issued the first blockchain bond on the Ethereum platform. Daimler has also placed a blockchain-based promissory note together with the German Bank LBBW.

- Governments - Democratic elections would be possible with this technology. This could be based on an agreement between the respective government and the citizens of the country. It would not only allow the government to see who voted, but also allow citizens to vote conveniently with one click.

- Energy sector - For example, electricity supplier RWE offers its customers Smart Contracts via the Ethereum platform so that they can easily pay for their electricity at electricity filling stations. Instead of cumbersome payment systems, vandalism of vending machines and the slow processing of payment transactions, electric car drivers pay by blockchain. The transaction is just as fast and convenient as cash - but without the security risks. Such systems are also possible for electricity customers who are also producers using solar cells in order to guarantee qualitative billing.

- Supply chain management - Supply chains of goods usually consist of several parties. From the consumer, via the retailer, the wholesaler, the company, the supplier and the producer, Smart Contracts on a blockchain basis can offer all parties a common contractual basis. The parties would then be able to track in real time what stage the product on offer is at.

- Healthcare - Patient-related data could be presented in a smart contract for the patient as well as for doctors and insurance companies. All data could then be visible at a glance. Patients could also decide individually which data they want to disclose.

- Real estate - Smart Contracts can not only regulate tenancies, but also simplify the purchase or sale of real estate.

Smart Contracts are tomorrow's type of contract - with Ethereum as a hyped pioneer

Smart Contracts are an innovation compared to conventional contracts. They could provide tomorrow's type of contract as their implementation provides security superior to traditional contract law, they facilitate the exchange of money, property and other valuables, they reduce transaction costs and resolve issues of trust between the parties. Theoretically, they have many uses. However, the technology and practical implementation are still in their infancy. Nevertheless, Smart Contracts are used in most crypto currency networks and are one of the most hyped features of Ethereum.