Smart contracts are well programmed to automatically execute two types of “transactions”. The first is ensuring the payment of funds upon certain triggering events and the second is enforcement of financial penalties if certain objective conditions are not addressed. In each case, human intervention is not required once smarts contracts have been deployed and are operational. Moreover, they help companies to overcome certain business challenges and ensure smooth functioning of businesses. But before that, let’s understand how do smart contracts work.
Smart contracts, also known as blockchain contracts, is a term that is used to describe computer codes that automatically execute all parts of an agreement. They automatically and securely execute obligations when defined conditions are met. Like every other blockchain-based technology, smart contracts are designed to function without reliance on a centralized authority.
How do smart contracts work?
Smart contracts allow the automation of transactions and authorize parties to agree with the outcome of an event without the need for a central authority. They record the terms of a contract and connects with banks’ internal systems or external world. After that, smart contracts wait for external triggers to evaluate pre-defined conditions and self-executes upon fulfillment of conditions via triggers. They then approve the execution of a transaction independently by allowing two or more parties to the contract. Shown below is one of our new multimedia slides on blockchain applications, and how smart contracts can help businesses.
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Challenges that can be overcome by utilizing smart contracts
Companies can easily excuse a breach by not enforcing the available penalties on the responsible parties with the traditional text contracts. Also, there can be instances, when companies willingly accept a partial performance on an ad hoc basis to preserve a long term relationship. However, the ability of smart contracts to automatically execute a transaction will not allow companies to enforce the agreement on an ad hoc basis. A late payment will result in the automatic extraction of a late fee or suspension of partners’ account partners if the smart contracts were programmed to do so.
Guarantee of payments
As parties constantly move their funds throughout the organization, delays in the delivery of payment becomes a common issue among parties. This, at times, results in legal arguments and conflicts in companies. With the help of blockchain contracts, companies can automate and render payments far more efficiently without the need for dunning notices or other collection expenses.
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Termination of contracts
In a traditional text-based contract, parties can easily change the parameters of their business deal at any point in time. They can even engage in, or threaten, so-called “efficient breach,” i.e., knowingly breaching a contract and paying the resulting damages if the cost to perform is greater than the damages they would owe. By employing smart contracts, the probability of amendment or termination of a contract reduces to zero. Even if companies try to, the amendment of a smart contract may yield higher transaction costs than amending a text-based contract and increases the margin of error.