Smart contracts: what they are and how they work

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Smart contracts are innovative tools made under the banner of theautomation. They are characterized by combining computer protocols with user interfaces to formalize and secure agreements between the parties involved within transactions.

Financial products officially introduced in the 1990s, although the idea of a smart contract (smart indeed) can be traced back to the 1970s.

In this article we tell you more about what are smart contracts and how they function in the current era. That of the Digital Revolution, a phenomenon that has had a not insignificant impact on all branches of the economy, including the financial sector, which has seen the focus placed on the smart contract with blockchain.


Smart contracts: what they are

 As we mentioned smart contracts have found new formulation following the advent of cryptocurrencies and the blockchain system. The Italian state was among the first to intervene with respect to the regulation of everything related to virtual currencies.

According to what was established in the Decree Law No. 135 of December 14, 2018 later converted into law on February 11, 2019, when it talks about smart contract refers to "a computer program that operates on blockchain technologies and whose execution automatically binds two or more parties based on effects predefined by them." A financial arrangement that is required to be able to "meet the requirement of written form upon computer identification of the parties involved."

To explain in the simplest way possible, blockchain smart contracts see the Transcription and translation of a contract according to a computer code, within which find form the conditions that it is essential to be met so that the operational definitions can be accomplished.

La logic is that if/the, i.e., of "if this situation occurs, then this other situation takes over," and is embedded directly within computer software and protocols.

Being particularly minute in terms, smart contracts need to be evaluated carefully, even more so by virtue of the fact that blockchain technology turns out to be decidedly recent (and not easy for everyone to understand). Best to avail oneself, therefore, of a IT and legal support, an element that, on the other hand, does not turn out to be necessary later on, i.e., at the time of verification and activation, since the procedures take place automatically.

Smart contracts: how they work

 Smart contracts present a decidedly broad scope of application, which should not, however, be considered unlimited. The boundaries are well defined, so much so that they are Solutions not to be confused or mixed with traditional contractual solutions, with respect to which the contract occurs solely at the legal level.

Smart contracts open up new professional opportunities and make possible a computerized transposition of agreements. But let's take a closer look, in concrete terms, at how smart-type contracts work, analyzing the necessary steps to be taken one by one:

  • Contract Stipulation. The parties agree on the terms of the smart contract.
  • Registration of the smart contract within the blockchain. The transaction remains fixed and thus cannot be changed in any way. The initial phase is the most delicate, precisely because it is final.
  • Blockchain users' evaluation of the blockchain using the PoW: Proof of Work mechanism. This is the consensus algorithm that underlies a network blockchain, is used on the one hand to confirm transactions, and on the other to produce new blocks on the chain. PoW, in fact, incentivizes miners to compete with each other in processing exchanges, so as an exchange they get a reward.
  • The contract is at this point monitored by a third party, unrelated to the two involved in the stipulation. If you think it is a natural person, you are off the mark: it is in fact an app or at least software, in most cases usable in a mobile version, that is, via tablet or smartphone. The fulfillment of the contract terms of smart contracts is drafted according to if/the logic from this software; automatic updates are sent directly to the parties involved.

Therefore, there are several clauses that may be present within the smart contracts, functional to make sure that the transaction is completed satisfactorily. Everything is defined and under control, including the steps to be taken if disputes occur.

Advantages and disadvantages of smart contracts

 I benefits that enable smart contracts are different, viz:

  • No need for intermediaries, such as notaries and lawyers, to verify and approve the contract. It may be helpful to have an expert involved just to be sure that the clauses are well balanced, but nothing more.
  • The code has no fluctuations or misunderstandings: there is no need for third-party involvement.
  • Economic savings, resulting from the fact that the procedures are achieved in full autonomy.
  • Saves time by virtue of a general simplification of contracting operations.

The critical elements Of the smart contracts to pay special attention to, however, are the following:

  • The language is in code: it is necessary to protect yourself that you have understood and adequately spelled out the conditions. It may prove useful to involve figures, IT and precautionary, during the pre-contract stage.
  • Once the contract terms are set, there is no turning back; everything remains as defined at the start. There may then be difficulties related to the willingness to implement measures such as withdrawal, cancellation, or termination of the contract.

Smart contract and finance

Blockchain smart contracts are seeing multiple fields of application, such as in insurance and logistics: branches in which they have already been introduced. They turn out to be tools that are destined for greater introduction in the future, by virtue of the fact that they are able to reduce (and not just a little) timeframes.

What is perplexing is the inability to adjust contract terms in the immediate aftermath should it prove necessary. Considering that smart contracts with blockchain are a fairly recent measure, they will surely go in the direction of improvement, resulting in even more prospects being available.

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