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The Digital Revolution - Part 2 Smart Contracts

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Last week I wrote about blockchains. This week I want to concentrate on smart contracts, what they are, how they work, and how they will improve business dealings. I will use two examples to show how things are changing: buying a house; and making an insurance claim.

Currently you find a house you'd like to buy. When you've sorted out the finance you go to a solicitor, who checks the details at the land registry, and maybe also checks with the local authority to make sure there are no plans to put a motorway through the front garden, or open a pig farm at the end of the road. All of this takes time, and means dealing with different organisations and checking various databases. It can easily take three months from your first decision to buy, to moving in.

Using a smart contract, things will be different. The first thing that will have to happen is the Land Registry putting all of its material onto a blockchain. It should add all information pertaining to every plot of land; in other words, government departments will have to list all decisions which are likely to affect the land. This will mean that all information will be in one place and downloadable. A prospective purchaser would be able (presumably for a fee) to look up the proposed purchase property's file, and make a decision there and then whether to go ahead with the purchase.

The buyer would then pull up a purchase contract, which would be a smart contract, and fill in the details, then pass the document to the vendor, who would fill their side of the contract. Part of the contract would stipulate that it would come into affect when the money was paid, and an electronic copy of the transaction would exist on the chain, and a copy would be on the hard drive of the parties' computers.

And you won't be using legacy banking for the transfer of money or setting up a mortgage. Both banking and mortgage facilities already exist in the digital world, and they will proliferate from here at a significant rate of knots.

Let's look at how things would have changed.
The deal could be done in minutes rather than months
There would be no need for any intermediaries
The conveyancer would be out of a job
There would be no paperwork
The smart contract would automate the transfer of funds
No-one would be needed at the bank to okay any transaction
The mortgage contract would be automated
Direct debits & mortgage funding would also be automated
OK. Smart contracts? What are they?

Glad you asked. They are an essential part of most of the really useful blockchains. Let's have a look at how they work.

Smart contracts use blockchain technology to verify, validate, capture and enforce agreed-upon terms between multiple parties. Smart contracts on the blockchain allow for transactions and agreements to be carried out among anonymous parties without the need for a central entity, external enforcement, or legal system. And these contracts operate on the Etherium blockchain. Other blockchains are beginning to see the benefit of such entities, and they will proliferate.

Let's now have a look at a totally different sort of smart contract.

I once read an article by someone who was intending to fly to Japan to attend a wedding. His plane was late taking off so he missed his connection. He didn't have enough money in his account to buy another ticket for a later plane. He claimed that if his insurance company had used smart contracts, there would have been no need to even make a claim against the insurance policy in the first place, he would have been paid out straight away after the first plane was so late that it meant a connection was missed.

A simple way such a contract would work is:
I buy insurance for 25.
The insurance company pays (say) 2000 into the contract. (That we are assuming is what I'd get if the insurer had to pay out on the contract.)
A set of commitments that have to be performed and at what times would be agreed.
If all goes well the 25 is paid to the insurance company. If there is a failure along the way that 2000 is paid to me.
Most contracts will be more complex than this, but that is the principle.

Let's go back to the guy who couldn't get to the wedding. How is that contract enforced?

The contract would have needed to have a lot more data fed into it. The whole itinerary would need to be provided for. If any part of the itinerary didn't hold up for some reason, then the agreed compensation would automatically and immediately be paid.

That leaves one crucial question unanswered; how would the contract know there had been a failure along the line?

Part of the smart contract would have to address this question, and it would involve consulting what is called an oracle. There would need to be an online database listing flight departures. The smart contract would ask a previously defined oracle to scan the departure and arrival times of the various connecting planes to see if they all left and arrived on time, or at the very least in time for the insured to catch a connecting flight.

The oracle would be chosen because it had the facility to scan arrival/departure times of planes at the relevant airports. That way the smart contract would know whether the conditions for a successful claim had either been met or not.

Initially this would be a bit complex to set up, but simple enough when the insurance company had done enough testing to get operational several template contracts that worked satisfactorily.

Once such smart contracts were in use, the checking of insurance claims would not need to be done by humans shunting pieces of paper this way and that to come to the facts of the matter.

Once again, the use of these smart contracts would save time and money. They would reduce rather complex dealings to a simple matter of activating a set of computer code to do the things needed. They would operate without any further input from humans. Great for disintermediation, and great for putting people out of work, but also great for making life a lot easier for most of us, and also great for cutting insurance fraud significantly. Welcome to the world of blockchains and smart contracts.

You can probably see that this new way of organising things is going to make many activities a lot simpler and a lot cheaper. At the moment blockchain is already being used in the more modern banking institutions. Blockchains are also in use in the logistics business. It is only a mater of time before we see most businesses working blockchain to blockchain. Those that dont will soon be regarded as positively Dickensian.

Next week I will deal with tokenisation. That is really going to set the cat among the pigeons.

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