Smart Contracts Use Cases

Smart Contracts

Smart contracts: What are they and how do they work? The Herfurtner law firm has compiled all relevant information on the definition and application of smart contracts for you. Smart contracts – explanation, definition, legal advice.

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Do you have legal questions about smart contracts? We will be happy to advise you.

Table of contents

  1. Smart contracts: Definition
  2. Smart contracts – legally binding
  3. Technical requirements
  4. The advantages
  5. Smart contracts – which ones are there?
  6. Smart contracts – where are they used?
  7. How secure are smart contracts?

Smart contracts explained simply

Smart contracts: What are they and how do they work?

Unlike traditional contracts, smart contracts are based on computer protocols. This is a digital contract based on blockchain technology. The buyer’s and seller’s contract terms are written directly into lines of code. Because smart contracts execute themselves when certain pre-determined circumstances occur, they do not require human oversight.

A transaction is automatically initiated when certain conditions are met, and then verified and recorded in a block.

In this way, transactions and agreements can be made between multiple parties who can be trusted.

Like traditional contracts, such as a sales contract or an insurance policy, these digital contracts are quite comparable. This type of error can be avoided because a smart contract is processed without human involvement.

A contract is an agreement between several parties. Therefore, a contract is always a legally enforceable declaration of intent by the contracting parties. They can conclude a contract in writing, orally and by conclusive behaviour.

For reasons of legal clarity, the contracting parties prefer written agreements. Such a contract must therefore always contain the general terms and conditions in addition to the clear identification of the contracting parties.

Smart contracts follow the same approach and contain all necessary contractual information. When the code for the software is developed, this information is already defined in it.

Consequently, smart contracts have the following characteristics:

The code is the law, and the law is the code.

It is a simple if-then rule that provides all the information needed to conclude a contract.

How do smart contracts work technically?

In its simplest form, an Ethereum smart contract is a tiny computer program that executes simple if-then logic. Programmers set conditions and actions upfront before automating the process.

Thanks to the blockchain, smart contracts are transparent, irrevocable and traceable in this context. Because these tiny applications are built on a blockchain, no third party can influence the settlement. Every transaction takes place on the blockchain, which reduces costs. Partly because of their independence, there are no time delays in smart contracts.

A distributed ledger treats these digital contracts like a separate account with a publicly accessible address, without actually having a public address, so no one has access to the private key.

Once the account is created, access from the outside is impossible.

In order for the account to automatically execute the content of the contract, the content of the contract must be described in terms of actions and conditions. By connecting and interacting with other accounts, it is able to connect and engage with them.

Are smart contracts programmed in a certain way?

Smart contracts can be created with Solidity, a contract-oriented programming language. You can use it with a variety of blockchains. At the time of its launch, Solidity was limited to the Ethereum blockchain. Right now, this programming language is used to create smart applications for various DLTs.

Developers only need a web browser to do their work. A client is required to compile the code below. Basically, the syntax of Solidity is identical to ECMAScript. The deterministic programming excludes random events. The nodes in the network validate the transaction as soon as the actual application has been executed.

Smart contracts: What are the advantages?

Smart contracts, which are based on blockchain technology, come into effect automatically when certain circumstances arise. So they do not need to be monitored by humans. When it comes to licensing or developing secure applications, this can be very useful for developers.

Technologies such as distributed ledger (DLT) are considered an important technology. Experts are focusing on blockchain technology in particular. This can improve many processes in the future and bring decentralisation to the fore. A decentralised and forgery-proof database, such as a blockchain, is created.

The smart contracts use cases of such a registry are diverse, but for companies, the automation potential is particularly interesting.

Smart contracts enable companies to automate a wide range of processes, which leads to additional value creation.

In terms of blockchain platforms for digital contracts, Ethereum is perhaps the most popular. Tezos, on the other hand, is a second blockchain that offers a wide range of features. Solidity, an Ethereum-specific programming language, can be used to create such a contract.

Features and benefits of blockchain smart contracts

Smart contracts have numerous advantages over normal contracts.

They include:

  1. Security: smart contracts are based on blockchain technology and are accordingly secured by cryptographic encryption methods. Therefore, no one can change the terms of the contract once it has been negotiated. With correctly programmed smart contracts, misinterpretation of the contract terms is almost impossible. In addition, all documents are stored in the blockchain so that they can no longer disappear.
  2. Speed and cost savings: Programming a smart contract only takes a few minutes before it is automatically executed. Creating and editing traditional contract forms is time-consuming and expensive, so automating the process saves both time and money.
  3. Decentralised organisation: Banks and notaries are no longer required as smart contracts are decentralised in their organisation. This validation process is now taken over by the blockchain. Due to the rule “code is law”, every contract must be legal in order to be valid.

Thanks to blockchain technology, smart contracts are now possible.

Originally designed for Bitcoin, blockchain technology can be used by developers for much more. Even more impressive is its ability to create “smart contracts” that can be signed without the involvement of expensive third parties such as notaries and still ensure legal certainty.

In conjunction with “if…then” conditions, smart contracts automate the execution of contracts. Of course, other database-based applications can also be equipped with blockchain technology, as the blockchain is basically just a decentralised database.

Automated compliance with contractual obligations

This means that contracts can be monitored and enforced at any time without human intervention, which is another advantage of blockchain technology, just like Bitcoin.

There may be delays in implementation in the company or at the customer’s premises if, for example, an employee responsible for licence management is absent. When using smart contracts, the question of compliance does not arise at all: P2P networks ensure that the terms of the contract are adhered to if they are implemented properly.

Smart contracts – these already exist

The areas in which smart contracts are already being applied in conjunction with blockchain are diverse. We have compiled a few examples for you here.

Insurance sector

  • Airlines: Claims settlement in case of defective indoor air quality and cancellation or delay of flights
  • Natural disasters and weather insurance
  • Unemployment insurance: processing of claims, approval and payment of unemployment benefits
  • Vehicle insurance: Calculation of repair costs, rewarding exemplary driving behaviour

Financial sector

  • Transactions in securities trading
  • Coupon payments
  • Financing of bills
  • Leasing: fees, insurance of vehicles

Smart contracts – a wide range of possible applications

Currently, only a few sectors around the world use blockchain on a small scale. Software licensing is just one of many possible applications of this technology. However, anyone who wants to use blockchain must also have the software.

Electricity suppliers. Weddings. Elections.

Blockchain is currently gaining acceptance in a variety of areas, including the energy sector, where flexibility is in demand. This leads to customisable electricity delivery options.

For electricity charging stations, the energy supplier RWE will use Ethereum’s smart contract platform. E-car users will be able to pay via the blockchain instead of using cumbersome and theft-prone payment methods and traditional banks and credit cards, which are notoriously slow to process.

The transaction is as fast and convenient as using cash, but there are no security concerns.

For electricity consumers who are also producers and have solar panels on their roofs to ensure fair and timely billing, such a system is now possible in other energy supply sectors.

As a result, other sectors will follow suit.

When it comes to human or business agreements, smart contracts based on blockchain technology make sense everywhere. For example, democratic elections or small contracts in the private sector are theoretically conceivable with this technology. Currently, people still have to go to polling stations and sign paper contracts.

Blockchain weddings are currently taking place in the United States, where both couples scan a QR code instead of being physically together. A blockchain database is used to legally record the “contract” (in this case the marriage).

The technology and its practical implementation are still in their infancy: the technology is there, but the application possibilities are far from mature. The fact that Bitcoin is so successful is definitely proof of how well it works and how secure it is.

In theory, there are no restrictions on its practical use in applications and services. The only problem is that those responsible have to be innovative in their execution in order to open up new business areas or simply save money.

Smart contracts: This is how secure they are

That smart contracts are considered one of the most important features of blockchains is no surprise. With the help of these small applications, contracts can be completely automated. They also offer a high degree of legal security, which makes attacks almost impossible.

Certainly, the functions are also interesting from a business perspective.

Insurance companies, financial service providers and energy suppliers, to name but a few, can benefit from them. So far, however, there are only a few examples of the successful use of this technology.

In addition, the challenge of integrating the new technology into the already existing laws and banking regulations has to be mastered. Questions and problems have to be clarified, such as how to deal with faulty programming of a smart contract.

In individual cases, the fulfilment of the requirements under contract law must always be checked.

If you have invested in or made payments to one of the companies on this list, our lawyers will be at your disposal at short notice.