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WTF are smart contracts?

  • Smart contracts are the digital, financial version of leaving instructions for the babysitter.
  • These computer programs are powering the robofication of finance.
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WTF are smart contracts?

You may not be able to see smart contracts, but chances are they’ve impacted your life in a meaningful way. From trading stocks to applying to college, smart contracts help companies automatically sift through data, automate fund transfers, and develop rules for new investing platforms.

Focusing on the financial instead of the technical aspects, here’s everything you need to know about smart contracts.

What are smart contracts?

Smart contracts are similar to directions you leave for the babysitter, telling her what to do if a specific event happens. From your kid waking up to an emergency situation, the instructions are triggered by specific events. Smart contracts are instructions programmed in a software platform that fire according to predefined rules.

Since smart contracts are computer programs, the easiest way to understand them without a background in programming is through examples. Here are three examples of how smart contracts are utilized by companies and individuals.

  • Institutions analyzing applications: Colleges evaluating prospective students and banks analyzing loan applicants utilize smart contracts to sort through data and separate the wheat from the chaff. Although institutions may call them algorithms, they are essentially a collection of smart contracts that make sure only suitable applicants are approved to go on to the next round of approval.
  • Automatically transferring assets or funds: Smart contracts can be set up at most online brokers as programs that buy or sell a security if it hits a certain price. Bookkeeping programs can automatically release payroll or give bonuses to sales employees after they meet predetermined quotas.
  • Investment vehicles run by smart contracts: The robofication of finance is dependent on smart contracts to invest automatically. Robos, quants and DAO funds utilize smart contracts to find investments, allocate funds, and buy or sell at specific price points.

Smart contracts are an integral part of blockchain technology and cryptocurrencies like bitcoin.

Why use smart contracts?

Smart contracts make life easier. It takes banks a lot of time to manually sift through every loan application, and smart contracts can help prevent human fatigue, improving decision making. Smart contracts can also help protect investments or capitalize on stock price movements by setting rules-based transactions. Essentially, smart contracts can help financial organizations and professionals save time, money, and energy.

What’s the problem with smart contracts?

Since a human writes the code defining the terms and limits to a smart contract, they’re only as smart as the person who wrote the program. Human error is still a factor in smart contracts, causing universities to accidentally send out acceptance letters to all applicants, or buying and selling stocks incorrectly after a forgotten limit order triggers, or when a hacker exploits a hole in one of the DAO’s smart contracts, siphoning away $50 million.

It’s cool that they’re everywhere, but why do smart contracts matter to me?

Smart contracts are the backbone behind the automation of finance. Correctly utilized smart contracts can help businesses and individuals sift through tons of data and opportunities to find quality information and automatically act on them. On the flip side, incorrectly designed smart contracts can be a death sentence for a business or portfolio. As smart contacts become more prevalent, understanding the underlying code behind a financial platform becomes more important, and professionals, investors and entrepreneurs alike will have to understand how smart contracts are utilized before finalizing a business decision.

 

Photo credit: jlcwalker via VisualHunt.com / CC BY

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