Smart Contract For Fintech - Definition And Use Cases
Smart contracts will define the future of legal and financial transactions, and will become the fundamental pillars of Fintech agreements. Whether you’ve simply heard of them and would like to understand if they can be beneficial for your business, you’re on the right page and can continue reading our following guide.
What is a smart contract?
It is one of the most hyped words used lately by blockchain developers and FinTech engineers.
Smart contract definition:
Smart contract is an agreement between buyer and seller that can be defined as the digital version of legal papers, a computer protocol, a code that verifies, or enforces the negotiation or performance of a contract without third parties, in a digital way.
It establishes the fundamentals in exchange of money, property, shares, or anything of value in a legal and transparent way without a third party and the consequent high fees faced.
When we buy a house, claim for insurance, request our medical history or any other credential to institutions, the process of data verification, validation and paperwork production requires lengthy and costly procedures because we have to rely on an intermediary to resolve the issue of trust between two parties and act as a guarantor.
Smart contracts are bringing simplicity to practical burdens which in Fintech is translated into the following:
- Speedier transactions that self-execute in the blockchain;
- Cost-effective transactions because the middleman figure is removed from the process;
- Trust-less transactions, where the middleman mediation is replaced by algorithms to trust;
What smart contracts offer?
- Efficiency — These self-executing contracts are quickly produced and self-executing, saving a lot of time normally wasted on manually processing paperwork, communication and delivery of the data.
- Sovereignty — As the need for an intermediate is eradicated, they give full control of an agreement or digital personal data management.
- Trust — We mentioned that algorithms replace the need of a third party and guarantee unbiased trust. Documents are encrypted and safely stored on a secured, shared ledger and cannot be stolen or changed in any way.
- Savings — A lot of money is saved on notaries, estate agents, advisors, assistance and many other intermediaries due to limiting third parties.
- Security — They are safely secured in a blockchain, protected by cryptography and are very difficult to hack because, since no single company or person controls them, there is no central point of failure to attack. Instead, the blockchain is a shared database run by many computers also called nodes that validate transactions with no censorship or limitations.
How does smart contract work?
As opposed to traditional transaction, smart contracts remove the need for third parties. The trust is guaranteed by maths and algorithms, which typically are unbiased, operate instantly and respond to commands and requests in a short time. All the functions performed by the intermediary can be coded into the smart contract.
Let’s break down the term and dive into a deeper understanding of how this one of the FinTech world’s most disruptive technologies work.
- A blockchain developer writes the smart contract’s source code, which is often open source and can be verified by anyone interested. The code contains all the business logic that the contract implements, i.e. who can perform what operations on it, and what happens when they do.
- The contract is deployed to the blockchain – now it has an address, which can receive transfers, like any other account in the network. It also has an interface, which specifies what functions are available on it.
- The parties interested in participating in contract execution can make transfers to it, with the function call details embedded in the transaction data. If the call is correct, the contract code is executed and it updates the it’s internal state, which will be reflected in the blockchain. An ERC-20 token contract can be an example – the contract’s internal state stores how many tokens the user accounts have, and whoever wants to buy the tokens, can do so by sending a transaction to the contract with an appropriate function call and some ETH.
- Sometimes the contracts have a deadline, after which some decision has to be made – digital voting is one such example. In that case, their code contains logic to be executed when the deadline is reached – for instance, it can count the votes, select an user who acquired the most, save them as a winner, and possibly grant them the access to some resource.
What is ‘smart’ about contracts?
The term ‘smart’ is used on a number of occasions to identify an efficient tool or management.
A smart city is a municipality that uses all technological resources available and connects them in order to make processes smoother and communication between people more efficient.
Think of smart cars or smart glasses, fully automated functional products and services that make use of the latest technologies to enable efficiency in a shared economy.
The “smart” in contract is not different to the examples above. It adds extreme efficiency to contracts, and since it self-executes in a trustless digital environment it is more reliable and robust than any other traditional agreement execution. This makes them unique and is referred to as "smart" in contracts.
What are currently the most popular smart contract use cases for Fintech?
Financial organizations can leverage smart contracts for accurate, transparent recording of financial data. They enable to uniform financial data across organizations, improve financial reporting or reduce auditing and assurance costs. Barclays Corporate Bank uses smart contracts to log a change of ownership and automatically transfer payments to other financial institutions upon arrival.
In car insurance, for instance, the claims process is fragmented but can be improved significantly through smart contracts. The smart contract records the policy, driving record and reports of all drivers, enabling Internet of Things-equipped vehicles to execute initial claims shortly after an accident. Automated insurance claims enabled by the contract provides instantaneous processing, verification and payment. Vehicles are able to communicate with each other and validate their own conditions.
Smart contracts can enable individuals to own and control their digital identity containing reputation, credentials, data and digital assets. This allows individuals to choose what personal data to disclose to counterparties, giving businesses the opportunity to seamlessly know their customers. Know Your Customer (KYC) processes are expensive and time consuming procedures but with smart contracts individuals own and control personal data.
Other Uses: Supply Chain
Smart contracts can provide visibility at every step of a supply chain allowing goods tracking across brands, retailers, logistics and contracted counterparties and reducing risks of fraud and theft. They offer simplification to a complex multi-party system delivery and can achieve granular-level inventory tracking and delivery assurance, potentially improving supply chain financing, insurance and risk.
IBM Blockchain supply chain solutions use them to automatically trigger when pre-defined business conditions are met. This gives near real-time visibility into operations, and the ability to take action earlier should there be an exception.
Smart contracts can be also used to rent cars, to charge electric vehicles, for digital rights transactions as various parties can avail copyrights once the negotiated license fee is released.
In energy sectors self-executing contracts are the perfect tool to ensure the generation and distribution of energy as per the agreed terms.
Besides, they also facilitate the easy integration of digital technologies like IoT through devices like smart meters that record the accurate flow of energy between users and producers and issue precise statements.
Which platforms host smart contracts?
Any blockchain can issue and store smart contracts digitally.
Started as a development within the Ethereum blockchain, nowadays other platforms compete to take that slice of the market that is growing by the day.
NEO (which by many is considered as the Ethereum of the Asian market), EOS and Cardano are other popular blockchain platforms where it’s possible to build smart contracts.
Bitcoin is also developing smart contracts though an upcoming project built on layer two of the base chain. Taproot will expand on Bitcoin’s smart contract flexibility, while offering more privacy in doing so.