MARCH 20, 2023
10 min read
Financial technology, or ‘fintech,’ refers to the use of computer algorithms or technology to enhance the financial industry. Since early 2014, government agencies, businesses, customers, and researchers have been closely monitoring the sector. Although blockchain initially gained recognition as the distributed ledger for Bitcoin, it has now gained popularity for use in other fintech services, such as payment processing.
The recent development of blockchain technology has led financial firms and other market participants to recognize the potential of fintech, and the introduction of smart contracts to the blockchain has significantly aided the development of the industry.
What are Smart Contracts?
Smart contracts offer a novel approach to contractual agreements. Rather than relying on traditional methods that involve both parties signing and exchanging paper copies of an agreement and resorting to legal action if one party fails to meet their obligations, smart contracts utilize blockchain technology to enforce compliance.
When a smart contract is executed, it becomes immutable, meaning it cannot be altered or revoked. This is due to the fact that the contractual terms are encoded in computer code, which will always execute according to the agreed-upon terms. As a result, smart contracts provide a fresh avenue for individuals, businesses, and government entities to enter into public and private agreements.
How Do Smart Contracts Work?
Smart contract use cases can include anything from supply chain management to insurance and real estate transactions. Imagine two parties who agree to a transaction and use a smart contract to carry it out. The contract is stored on a public blockchain, ensuring its authenticity and execution. Each party has their own private cryptographic key to sign the contract digitally.
- Digital Signatures: Cryptographic digital signatures are employed by each party to verify their involvement in the contract.
- Oracles: Agreed-upon data sources inform the contract’s logic. Both parties rely on this information to determine whether the contract’s conditions have been met.
- Self-Execution: Once the specified conditions have been fulfilled, the contract can autonomously fulfill itself without necessitating further action from either party.
The blockchain network copies the contract to multiple computers, making each device a witness to the contract’s validity, much like a notary public. The smart contract instructs all devices on the network to confirm that the terms have been met. To do so, they can rely on an oracle, a third-party data provider that reports when an event has occurred, such as a payment or shipment. To create a smart contract, one must understand how to write a smart contract in code and utilize oracles to verify the conditions of the agreement. Even labor negotiations can utilize smart union contract negotiations to ensure fair and transparent agreements.
Although the diagram below represents four straightforward steps, the use of smart contracts can involve a wide range of variations and, as a result, can become considerably more intricate.
What is the problem solved by Smart Contracts?
Written contracts are common in businesses of all sizes and industries, but they can often be cumbersome and a source of commercial and legal disputes. Smart contracts provide an effective solution to these traditional contracts by simplifying business and commerce between parties without requiring an intermediary. This results in reduced formality and costs while maintaining credibility, security, and authenticity.
While smart contracts have yet to be widely adopted, their numerous advantages cannot be overlooked. Here we will explore five key benefits of employing smart contracts.
- Enhanced Security
Blockchain transaction records are highly secure due to encryption, making it challenging to hack them. Smart contract development services and smart contract security are essential for businesses that want to leverage this technology Additionally, since each record is connected to the previous and subsequent records on a distributed ledger, altering a single record would require hackers to modify the entire chain.
- Automation and Innovation
Smart contracts have the capability to automate the movement of digital assets and payments, potentially leading to new products and business models in the fintech industry. For instance, smart contracts can facilitate agreements allowing daily payments rather than the conventional weekly or monthly payments in the industry. Solana smart contracts are utilized on the Solana blockchain, and numerous smart contract platforms, such as Ethereum and Cardano, offer developers the ability to create and deploy their own smart contracts.
- Increased Efficiency and Accuracy
Smart contracts are instantly executed once the specified condition is met. Since smart contracts are digital and automated, there is no need for manual paperwork processing, which eliminates time spent reconciling errors commonly resulting from manual document completion.
- Reduced Costs
Smart contracts eliminate the need for intermediaries to facilitate transactions, resulting in a cost-free execution process without time delays and associated fees.
- Improved Transparency and Trust
As there is no involvement of a third party and transaction records are encrypted and shared among participants, there is no need to suspect any alteration of information for personal gain.
Use Cases of Smart Contracts in Business
Smart contracts were initially introduced to the public by Nick Szabo, a notable figure in the legal and cryptography fields, who mentioned them in a paper back in 1995. However, it was not until two years later that Szabo published a more comprehensive paper outlining the theory, although its practical application was hindered by the lack of adequate technological infrastructure at the time. It was only in 2009, with the emergence of blockchain technology and bitcoin, that smart contracts became a viable and practical reality. There are various smart contract examples, including NFT smart contracts used to manage the transfer of non-fungible tokens and WP smart contracts used in WordPress development. NFT smart contracts are an example of how this technology can be used to revolutionize the art industry.
After gaining an understanding of how smart contracts operate, it would be beneficial to examine some real-world examples of their application.
**Supply Chain Management
**Smart contracts can function independently without intermediaries or third parties, making them self-executing agreements. For example, if a smart contract was created for a supply chain, it would not require daily monitoring or auditing. Instead, any deliveries received outside of the agreed-upon schedule could trigger predetermined escalation measures to ensure seamless operations.
Australia’s first full-service agricultural supply chain platform, Datahash (formerly Entrust), is combating the $3 billion fraudulent wine market by utilizing the Hedera Consensus Service to establish a trusted way of tracing its data.
Real Estate Transactions
Smart contracts can be utilized to enable fractional ownership of real estate, dividing the ownership of a property into tokens that can be purchased by multiple individuals. Each token represents a specific percentage of ownership in the property, allowing for micro-investments and a more accessible entry into the property market.
Insurance Claims Processing
The insurance industry is notorious for being riddled with disputes, making smart contracts a promising solution for automating policies and services. This technology has the potential to lower insurer costs and subsequently reduce premiums for policyholders. Additionally, smart contract-powered automated claims payment processes can expedite payments to policyholders, surpassing the speed of current manual processes.
Digital Identity Verification
Smart contracts can be utilized to create digital identity by storing various components, such as reputational data or digital assets. You can connect such an identity to online services without disclosing the individual’s identity. Additionally, smart contracts can store credit scores that lenders can use to evaluate the borrower’s potential risk.
MyEarth ID is an example of a decentralized identity management system that empowers users to manage their digital identity data and validate it securely with third parties.
Capturing Financial Data
Smart contracts have the potential to simplify and make data collection more transparent. Specifically, smart contract audit costs can be significantly lower and ensure adherence to regulations when it comes to financial record-keeping. Moreover, smart contracts are self-executing and can follow preset financial guidelines without any human intervention, which can improve administrative processes and reduce the workload of accountants.
In another application of smart contracts in the financial industry, AllianceBlock is developing a protocol called AllianceBridge, which aims to connect decentralized finance (DeFi) with conventional financial services (TradFi).
Challenges and Limitations of Smart Contracts
Although smart contracts offer numerous advantages, no technology is infallible. There are a few drawbacks to consider:
- Human Error
Despite the automation of smart contracts, they are still coded by people. To create a smart contract, a developer must use a smart contract language compatible with the chosen blockchain. As a result, some mistakes can appear anytime while making and incorporating the contract. You may minimize this risk if you hire the right team like DashDevs.
The absence of comprehensive government regulation for smart contracts, along with other blockchain-based technologies, is a concern. While some may view this lack of regulation as a positive aspect, it can be a precarious situation due to the previous experiences with fintech regulation. If government agencies decide to impose regulations on smart contracts, users may find it challenging to navigate uncertain regulatory waters. Yet, such regulations are absent today.
- Ambiguity in contract terms
Smart contracts may struggle to handle terms and conditions that are unclear or not well-defined, as traditional contracts often contain such clauses.
What is the Future of Smart Contracts?
As the technology continues to evolve, we may see the development of more complex smart contracts that can handle more sophisticated business processes. These contracts may incorporate advanced features such as artificial intelligence and machine learning to enable even greater automation and decision-making.
The potential of smart contracts is evident, as they are already being utilized in smaller enterprises and serving as the foundation for various blockchain initiatives. Smart contract development companies provide services to clients seeking to develop their own smart contracts, while smart contract auditors review and verify the code for errors or vulnerabilities However, their full potential in the realm of centralized finance is yet to be realized.
The responsibility falls on the smart contract developers to implement them with a thorough comprehension of how they can benefit their specific industry and with the incorporation of robust security measures to guarantee the smart contracts operate as intended and cannot be tampered with.
The use of smart contract blockchains is another critical aspect of smart contract implementation. Despite potential challenges, the benefits of smart contracts make them an exciting and promising technology for the future.
Smart contracts provide a solution to the issue of trust in the digital realm, promoting honesty, security, and fairness. The use of smart contracts continues to gain traction in various industries. There are numerous examples of smart contracts, including NFT smart contracts for the sale and transfer of digital art, and ether and Solana smart contracts for decentralized finance (DeFi) applications. By incorporating these protocols into your enterprise, these contracts ensure that multi-party agreements maintain their integrity and that set obligations, such as those pertaining to loan and intellectual property applications, are automatically enforced. They can also validate insurance eligibility and establish decentralized autonomous organizations, among other applications.
If you’re considering incorporating smart contracts into your organization, now is an opportune moment to investigate their potential. The possibilities are virtually endless. By leveraging DashDevs capabilities, you can develop decentralized protocols and applications that expand in conjunction with smart contracts.
How are smart contracts different from traditional contracts?
Smart contracts are different from traditional contracts in that they are self-executing and automatically enforceable through computer code, while traditional contracts require human intervention and legal enforcement.
How smart contract auditing works?
Auditors review smart contract code for errors and vulnerabilities to ensure the contract operates as intended and is secure from hacks and attacks.
How do smart contracts work and what are some examples of smart contract use cases in the fintech industry?
There are several smart contract use cases in the fintech industry, including:
- Automated payments and settlements: Smart contracts can automate the process of executing and settling financial transactions, reducing the need for intermediaries and speeding up the settlement process.
- Loan origination and servicing: Smart contracts can be used to automate the loan origination process, from underwriting to servicing, reducing the need for manual intervention and lowering costs.
- Trade finance: Smart contracts can help automate the trade finance process, from issuing letters of credit to settling payments, reducing the risk of fraud and improving the efficiency of the process.
- Insurance claims processing: Smart contracts can be used to automate the claims processing process, from verifying claims to disbursing payments, reducing the need for intermediaries and improving the speed and accuracy of the process.
How Ether smart contracts work?
Ether smart contracts are self-executing agreements that run on the Ethereum blockchain, enforcing terms and executing actions automatically.
What is the role of blockchain technology in smart contracts?
Blockchain technology provides a secure and decentralized platform for executing and enforcing contract terms. Smart contracts are self-executing and operate on a distributed network of nodes that validate and record each transaction on the blockchain, ensuring that the contract terms are transparent, tamper-proof, and irreversible.
By leveraging blockchain technology, smart contracts can provide a high level of security, transparency, and immutability, making them ideal for use cases where trust and reliability are paramount. Additionally, blockchain technology can help reduce the need for intermediaries and streamline the contract execution process, resulting in faster and more efficient transactions.
How to create a smart contract, and what programming languages are commonly used for this purpose?
To create a smart contract, you need to follow these general steps:
- Identify the problem or use case that the smart contract will address.
- Define the contract terms and conditions.
- Choose a blockchain platform or network to deploy the smart contract on.
- Write the smart contract code using a programming language supported by the chosen platform.
- Compile and test the smart contract code.
- Deploy the smart contract to the blockchain network.
Solidity is the most commonly used programming language for creating smart contracts on the Ethereum blockchain. Other blockchain platforms, such as Hyperledger Fabric and Corda, support different programming languages, such as Java, Kotlin, and Go. It’s important to choose a programming language that is supported by the chosen blockchain platform and that best fits the requirements of the smart contract being developed. A smart contract development company can help with this process.