The development of distributed ledger technology has ushered in a new era of digital solutions that help provide a new level of human-money interaction based on an agreement between them. If earlier, the parties’ agreement had a purely superficial character, the conditions of which were often not fulfilled. Still, today smart contracts are designed to solve this problem, which finds their practical application within different spheres of human life, setting the trend of the fintech industry.
In this article, you will learn what smart contracts are, where they are used, and what trends they are setting today. You will also know how smart contracts will be used in the future.
- A smart contract is a digital contract that establishes the rules for fulfilling the terms of the agreement between the two parties, ensuring the full performance of the obligations laid down on the basis of the contract.
- Among the main smart contract use cases are the healthcare sector, the media sector, the Internet of things and the lending sector.
- Among the trends in the development of smart contract technology today are syntactic assets, algorithmic stable coins and the tokenization of the investment portfolio management process.
What is a Smart Contract?
A smart contract is a computer program that automatically executes bilateral or multilateral contracts that require compliance with the terms specified therein. A smart contract differs from an ordinary paper agreement in how it is written, the concept of compliance, and the legal implications. The terms of the contracts are drawn up by the parties involved. Activating the software code results in certain actions aimed at fulfilling the contract.
Digital contracts are created using a special programming language. The code of the electronic agreement is executed automatically. After analyzing the relevant information, the program performs certain operations following the terms of the agreement. The smart contract is executed in all the network participants and recorded in the blockchain. Each electronic agreement has its own address where its functions can be called.
The execution of an electronic agreement may depend on data from external sources of information. Special Internet sites are used to obtain such information. An example is a service that supplies information about stock quotes. When a digital agreement is executed, a so-called audit trail is formed, which allows for revealing the sequence of actions of the agreement participants. A computer contract is cryptographically protected from attacks by cybercriminals.
Smart contracts are used to execute transactions on the blockchain and allow automatic control and verification of information recording. The terms of such contracts are formalized and translated into the programming language. Open to all blockchain participants, a smart contract development can have any degree of complexity. There is a set of interconnected transactions on the network and all the information the smart contracts have generated. Therefore, one digital contract can be linked to other agreements.
Areas of Use of Smart Contracts
Smart contracts are spreading rapidly worldwide and gaining momentum every day. To a large extent, this is due to the many advantages that smart digital contracts offer. They allow for optimization, speed up many routine processes, and reduce (or completely eliminate) an intermediary party’s involvement, significantly reducing the associated costs. Also, implementing smart contracts technology eliminates possible errors due to human error. Therefore, in recent years, digital contracts have begun to be used in various spheres of activity in addition to cryptocurrency. Here are some smart contract usage examples.
- Sphere of Lending
There are many transactions related to the disbursement and repayment of credit funds. Applying blockchain technologies based on smart contracts allows prescribing algorithms in the network code. Thus, payment history, security, fraud detection systems, automatic lending, etc., are greatly facilitated.
In addition, smart contracts technology in lending provides optimized control over the movement of assets with the ability to continuously monitor and reveal the status of the property left as collateral for mortgages. When combined, these factors can greatly simplify the banking industry and reduce the associated overhead. An example, blockchain enabled smart contracts in banking is the Spanish bank BBVA (Banco Bilbao Vizcaya Argentaria).
- Sphere of Health
Medical records are an integral part of managing the treatment process. Smart contracts can create patient profiles on the blockchain, allowing physicians and related medical practitioners to view past medical records. This would allow them to develop more effective treatment procedures based on the patient’s past treatment history and subsequent outcomes. Such a setup would save lives and help doctors avoid the problems associated with medical malpractice.
Medical centers can also set up smart contracts to track health complications arising from treatment side effects and code them to share information with drug manufacturing partners and medical associations that have yet to disclose all the side effects of new drugs.
Some smart contract systems can generate unique anonymous identifiers to identify each patient without revealing their identity, to protect their privacy. Moreover, smart contracts enable being configured to block unauthorized access while allowing records to be verified by staff, partners, and regulators.
- Media Sphere
People who produce their content in the field of art and intellectual property (music, painting, video shooting, photography, poetry, films, etc.) should receive a decent reward for their work, which, in turn, should be copyrighted.
The application of blockchain technologies with the integration of smart contracts can automate most of the routine processes in the media space. They will enable the correct crediting of payment funds and the distribution of profit shares between the author and the production company. This will greatly speed up the process and make it less costly.
- Internet of Things
IoT (Internet of Things) is a new, promising trend with rapid development, gaining momentum daily. It needs a unified system that combines electronic devices and personal gadgets for its correct functioning. Blockchain technology based on smart contracts could be the ideal solution for these processes.
Smart contracts promise to automate processes that run on the Internet of Things (IoT) and peripheral computing devices (Edge Computing). For example, a utility company might offer a service in which advanced smart contracts can be executed in response to changes in electricity rates in coordination with devices embedded in electricity meters. For example, when prices reach a predetermined threshold, a smart contract can automatically turn off especially energy-intensive devices like air conditioners.
Current Trends in Smart Contracts
Blockchain development has been the foundation for a great deal of research aimed at changing its capabilities, much of which lies within the use of smart contracts changing the usual understanding of many things today. The use of smart contract technologies has enabled the concept of a new form of interaction between different subjects of blockchain systems, which is embodied in the following trends.
- Tokenized Investment Portfolio Management
A unique example of smart contracts is noncustodial “smart portfolios”, which automatically rebalance each user’s portfolio by executing trades according to conditions predetermined by the portfolio owners. This provides users with advanced financial products programmed to execute trades at the current market prices of specified assets and tokens. Such trading strategies can be tokenized, allowing users to transfer and use these tokens within other smart contracts and decentralized applications.
Various services use price flows using smart contracts to tokenize positions that execute trades on behalf of their users. Moreover, users can use their tokenized positions as collateral within other protocols to improve investment efficiency. The algorithms are based on technical analysis of all sorts of metrics, such as RSI, moving averages, etc., created specifically to track major trends in price movements.
- Synthetic Assets
The DeFi movement is based on openness and transparency. As such, synthetic assets are a concept derived from derivatives in traditional finance. Thanks to decentralized protocols and exchanges, the mining and burning of synthetic assets is not controlled by a central authority, but by a public ledger that records and verifies every transaction. With smart contracts, there is no need for intermediaries, so users can use them that control and execute every transaction.
Most synthetic asset protocols use oracles, such as Chainlink, to collect accurate data about the underlying asset’s value. The process of buying and selling each synthetic asset token is supported by smart contracts, which are automated lines of code containing each transaction’s terms.
- Automated Asset Management
Smart contracts can be used to automatically execute various trading strategies at preset time intervals. However, a set of variables can affect the profitability of strategies, particularly considering the cost of gas in transactions. Therefore, traders using automated systems need reliable information from oracles to ensure consistent profitability when executing trades.
There are already companies on the market today that offer such a solution. They use the technology of a decentralized transaction automation service to rebalance the liquidity of positions when preset thresholds are crossed. New and existing capital is strategically rebalanced between active liquid positions and individual limit orders, allowing the protocol to maintain the highest utilization of each asset.
- Liquidity of Financial Markets
An AMM is a type of market maker that relies on smart contracts, and smart contracts independently buy and sell orders based on predefined commands, eliminating the presence of a third party. AMMs are most common on decentralized exchanges (DEX) and other peer-to-peer (P2P) decentralized applications (dApps) on the blockchain. This makes them easily accessible because anyone can buy and sell cryptocurrencies without an intermediary.
Today, algorithmic trading and automated market maker systems are being actively developed to replace classical ways of delivering liquidity to financial markets. Automated market makers work with liquidity pools, which, in fact, are crowdsourced funds of a particular trading pair operating based on smart contracts regulating the terms of each transaction within a specific platform.
- Algorithmic Stablecoins
Stablecoin is called algorithmic when its value is backed by smart contract algorithms rather than backed by paper money or other digital assets. This can provide many advantages, such as faster settlement, lower transaction costs, and greater liquidity.
Algorithmic stablecoins are usually backed by collateral on the blockchain, either deposited by users themselves or provided by third parties such as credit providers and investors. This creates a CDP (collateralized debt position), an agreement between a borrower and a lender to exchange one asset for another at a certain time or when certain conditions are met. The smart contract algorithm will then use this CDP to maintain a stablecoin peg and ensure it is pegged to the target currency.
Also, algorithmic stablecoins are very secure due to the decentralized nature of smart contracts that maintain the binding between the stable coin and its underlying asset.
- Self-Repaying Loans
Self-repaying loans are a new financial product powered by smart contracts, made possible by an ecosystem of decentralized finance. Protocols that offer self-repaying loans allow users to add their assets as collateral and to borrow/issue synthetic assets for working capital. The collateral, meanwhile, is sent to the farming protocols, and the resulting income is used to automatically pay off the loan. Thus, a highly efficient debt instrument emerges, which, thanks to the development of smart contracts, will have further development to develop new forms of crypto lending.
Future Outlook of Smart Contracts
Smart contracts are complex process logic, and their potential goes beyond the simple transfer of assets. They can perform transactions in various areas, from legal processes to insurance premiums, crowdfunding agreements, and financial derivatives. Smart contracts could eliminate mediation in the legal and financial fields by simplifying and automating the routine and repetitive processes for which people currently pay banks and lawyers significant sums.
The role of lawyers may change in the future as smart contracts gain capabilities such as the adjudication of traditional legal contracts and customizable smart contract templates. In addition, the ability of smart contracts to not only automate processes but also monitor their flow, then their potential for real-time auditing and risk assessment can be helpful in regulatory compliance.
Smart contracts can be used to create different types of digital assets, such as tokens that can be used to exchange for other assets. They can also create conditions under which specific actions are performed, such as automatic funds transfer when certain conditions are met. Such a solution will help to increase the efficiency of payment systems, the development of which today takes place in the plane of Web3 solutions and implies the integration of instruments operating on blockchain innovations, one of which is the technology of smart contracts.
On the other hand, with the help of smart contracts can show themselves perfectly in supply chain management, giving logistics companies the to establish a chain of goods movement (tracking), which allows you to track the movement from the point of origin to the destination, including and detailing all the intermediate stages (shoulders) of the events of transportation. This increases security and reduces the number of “gray” zones (areas without information on cargo movement) and lost shipments.
Smart contracts can define delivery terms, including timing, routes, volume, shipment characteristics, and service charges. They can also automatically determine the price of transportation based on transportation rates, both their own and those of service providers, without the involvement of intermediaries: banks, insurance companies, and agents, making the contracting process more efficient. Smart contracts can also automate payment and financial accounting processes, allowing for the automatic calculation of amounts and payments to suppliers and carriers without intermediaries. This speeds up the process of sending and receiving payments.
Today, the global smart contracts market is developing with great speed, which contributes to smart contract applications covering more and more areas of life. Developing smart contracts makes it possible to see the great progress underlying the symbiosis of blockchain and financial system technologies, reflected in smart contract platforms’ market growth and the flourishing market of related crypto-technological solutions.