How Will Smart Contracts Change Traditional Investments?
Remember the contracts of yesteryear? You know, a heap of paperwork thick enough to serve as a doorstop, with long spells of hurry up and wait?
You’re not dealing with your grandfather’s contracts anymore. And while you might work with a few types of investments your grandparents or parents once used, that doesn’t mean you need to use the same contracts.
With a smart contract, traditional investments have a brighter future. Here’s what savvy investors should know about the potential future for traditional investments as shaped by smart contracts.
What are Smart Contracts?
First, it helps to understand the basics—what a smart contract is and how it functions.
A smart contract is a digital contract stored in blockchain, with the terms of the contract agreement written into the lines of code. Beyond writing the terms, the contract itself is fairly straightforward: it automatically self-executes when the terms of the contract have been met.
The idea was first introduced in 1994 by an American computer scientist called Nick Szabo, who defined smart contracts as computerized transaction protocols that execute the terms of a contract. He also envisioned smart contracts as a way to standardize derivatives contracts with highly complex terms, thus lowering the transaction costs associated with such contracts.
How They Work
While the terms attached to each smart contract vary, all smart contracts rely on a series of if/when conditional statements. These are written into the code of the contract, and the contract (including its completed terms and full code) is recorded in blockchain. The blockchain computer network then uses those if/when statements to execute the contract automatically when the predetermined transaction conditions are met and verified.
For example, let’s say you’re using a smart contract to buy a painting. Your contract might include a statement like, “When Mr. John Doe signs the purchase agreement, $1,000 in funds will be withdrawn from Mr. Doe’s account ending WXYZ to complete the purchase.” Once the contract registers a signature, it will execute the contract terms—in this case, depositing funds for the purchase. Once the transaction is complete, it is recorded in the blockchain so it cannot be modified or deleted.
Because the contract executes itself without input from involved parties, both sides have to be very careful when negotiating the terms. If you make a mistake, the contract won’t know the difference. It’s just a computer program following instructions. As such, all involved parties have to carefully negotiate all possible exceptions, as well as consequences if either party fails to fulfill their side of the agreement.
Smart Contract, Traditional Investments: What the Future Could Hold
With smart contracts, traditional investments have a bright (and exciting) future ahead of them.
In many ways, smart contracts introduce investors to a completely new vocabulary—and that’s a good thing. They have the potential to radically alter the speed at which business gets done. But it also goes deeper than pure convenience. It’s a different way to do business, to the benefit of your investing results.
Here are a few ways that smart contracts may shape the future of investing.
The Power of Automation
One of the major changes will come from the nature of smart contracts: automation. Unlike traditional contracts, both parties don’t need to engage with each other, nor do they need to execute the contract manually—the contract executes itself once the conditions have been met.
For investors, that’s a huge deal.
While our current global investment market offers a lot of exciting opportunities, it also presents a number of challenges for transactions, and the biggest challenge is time. Smart contracts can radically improve the efficiency and accuracy of transactions and recordkeeping, allowing investors to move faster on worthwhile investments.
Another key benefit is transaction transparency, which is a major benefit attached to many forms of blockchain technology.
Picture a mile-long pharmacy receipt. Blockchain is a database arranged like one of those mile-long receipts, with a chronological record of every transaction that ever occurred within that chain. Because every node in a blockchain network has to verify every transaction, and every node can add new transactions at any given time, it’s all but impossible to alter the transaction details. And as long as you have access to the blockchain, you can see the details.
Basically, smart contracts eliminate the need to worry about transaction details. It’s a trustless system—as in, a system that doesn’t require trust to operate successfully.
Ideal Uses for Smart Contracts in Traditional Investing
That said, while smart contracts offer exciting prospects, they work best when used properly. In the case of traditional investments, smart contracts are most successful when used on the right type of transaction.
Basically, smart contracts are best suited for agreements between two or more parties without third-party validation, such as contract execution when the triggering event can be measured digitally. Otherwise, smart contracts won’t know when the conditions have been met, and it eliminates the point of using a smart contract in the first place.
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