Smart Contracts - What Every Investor Needs to Know
Blockchain technology is revolutionizing industries across the board. One reason for this is how the technology has facilitated the evolution of automated smart contracts, which do away with the need for intermediaries.
As smart contracts become more commonplace, it's crucial for investors to understand them. Unless we can assess the associated risks and adequately consider any legal implications, we cannot explore a comprehensive range of investment opportunities.
What Are Smart Contracts?
Built on the blockchain, smart contracts are self-executing contracts with the terms of the agreement directly written into code. The code automatically executes actions when specific predefined conditions are met. For example, releasing a payment could automatically grant the payee access to specified goods or services.
Smart contracts utilize cryptography to ensure the security and integrity of transactions. This ensures they are transparent, immutable, and irreversible, so parties to the transaction are assured of performance without delays or reliance on third parties.
Some Examples of Where Smart Contracts Are Used
One area where smart contracts are rapidly being implemented is in the complex arena of supply chain management. Here, they can enhance the traceability of products and materials, thus streamlining administrative processes and cutting costs. At the same time, there is potential for them to address environmental, social, and governance goals.
Smart contracts are also used to eliminate intermediaries in financial transactions. In decentralized finance (DeFi), they enable peer-to-peer transactions using cryptocurrencies, for example. And they could automate traditional manual processes like loan approvals, identity verification, or insurance claims.
Advantages of Smart Contracts
The intermediaries that conventional contracts often rely on, like banks and lawyers, can introduce unforeseen and unwelcome costs and delays. And where conditions or events are open to interpretation, the parties to the contract could find themselves with a result they didn’t anticipate. Smart contracts can avoid these unintended consequences and also guard against human error.
Conventional contracts and conventionally monitored events are also vulnerable to being fraudulently altered or falsified. However, because smart contracts are stored across multiple nodes in the network on the blockchain, the risk of fraud is close to zero. This allows parties who don't know each other and who may have never meet face-to-face to contract confidently.
The speed and accuracy with which smart contracts operate are making transactions possible that conventional modes of business couldn’t facilitate. For example, it's easy to have substantial fractional ownership schemes when processing investor events is automated. When they required human intervention of any sort, the costs outweighed any benefit to the many small investors.
Smart contracts are also making new business models possible. For example, artists can monetize their creations by creating smart contracts that automatically distribute royalties to them whenever their work is sold or used.
Possible Risks Associated with Smart Contracts
While smart contracts offer many benefits, it's essential to consider the potential risks and challenges associated with their implementation. One challenge is the complexity of coding the contract's terms and conditions. Smart contracts require precise and error-free coding to ensure accurate execution and avoid vulnerabilities that malicious actors could exploit.
Additionally, the immutability of smart contracts can also be a double-edged sword. While it ensures transparency and engenders trust, it also means that errors can't be easily corrected. This highlights the importance of a thorough testing process that catches errors before contracts are deployed.
Another risk to acknowledge is the potential for legal ambiguities or jurisdictional issues. Conventional contracts typically rely on judicial court systems to resolve disputes or enforce terms. However, with smart contracts, the code itself determines the outcome, leaving less room for interpretation and external intervention. As the adoption of smart contracts grows, legal frameworks and regulatory standards surrounding them are still evolving. It's essential for investors to conduct due diligence and consult legal experts to ensure compliance with applicable laws and regulations.
Smart contracts provide investors with exciting opportunities to optimize investment processes, like dividend payments or trade settlements. They are also making it easier to take advantage of the fractionalization of assets to participate in markets that were once restricted to more prominent institutional players. And there are several new asset classes available thanks to smart contract technology.
However, investors must remain aware of the associated risks and perform adequate due diligence before investing. Carefully consider any legal ramifications, and always ensure you have an adequately diversified portfolio of investments.