Smart Contract

Smart contracts are computer protocols which are linked to tokens. They can be used to represent contractual agreements in an automated and particularly secure manner. Smart contracts map the rights and obligations of a legal contract and are represented by tokens.

Smart Contracts are self-executing contracts where the terms of the agreement between buyer and seller are written directly in lines of code. The code and the agreements contained in it exist over a distributed, decentralized block chain network. Smart Contracts enable the execution of trustworthy transactions and agreements between different anonymous parties and without the need for a central authority, a legal system or an external enforcement mechanism. Smart Contracts make all transactions traceable, transparent and irreversible.

Smart contracts facilitate decentralized execution of "agreements."

The digital contracts are programmed as executable programs that are automatically checked and executed (i.e. "fulfilled") when a certain (predefined) condition occurs. Such an event can be, for example, a transaction between two parties, or a participation right. All agreements are stored in the smart contract, as well as the number of tokens and their respective equivalent value. In this way, when a dividend or interest payment is made, each token holder receives the (percentage) amount due to him in coins (e.g., Ethereum) on a pro rata basis.
A token in this case can be compared to a security, i.e. the right to participate in profits, distributions, etc, while a coin can be compared to the asset behind it, i.e. the equivalent of US dollars, euros, or gold. For more information, please see here.

In the blockchain realm, smart contracts are usually run via the "Ethereum Request for Comments"-20 token standard, known as ERC-20. Since smart contracts are mapped and implemented completely digitally, no person or third party needs to be involved for their verification and execution. Thus, smart contracts fall under end-to-end encryption.

Automate costly processes, from dividend distribution to investor onboarding, using smart contracts – secure and without the need for intermediaries.

In the financial sector, smart contracts are particularly suitable for transaction banking and issuing. So far, they have been used primarily in the areas of trade finance and syndicated loans. Additional areas of application include interest and redemption payments, purchase price discounts or credit notes. Smart contracts are also an outstanding tool in the insurance sector, for example to automatically adjust insurance premiums depending on the claims history. In the future, smart contracts will also play a key role in creditworthiness and credit rating checks, because they ensure a high level of security and data protection and create trust without the two parties to the transaction having to provide an insight into their books or bank account.

In other industries, too, smart contracts will increasingly replace ordinary contracts. A rental agreement, for instance, can be processed immediately and replace the classic "if-then" sequence: Typically, a tenant must first request and submit a credit report to the landlord, then both parties must sign the lease (which can take a while and is often done by mail) before the tenant transfers the deposit and first rent, and subsequently receives the apartment keys. With smart contracts, this time- and energy-consuming process is reduced from several weeks to just a few minutes.

How is a smart contract executed?

Smart contracts on blockchains as Ethereum are treated as accounts that act autonomously - without individuals having access to the actions to be performed or being able to, for example, manually interrupt individual actions or deceive either party. Instead, the account (the program code, in other words, a collection of programmed instructions) is responsible for all calculations, executions, transactions, and storage. In this respect, smart contracts are only as secure, or "error-free," as their program code. Thus, the principle of "code is law" applies.

How secure are smart contracts?

Provided the program code is error-free, smart contracts are extremely secure from a technical point of view. However, it is important to differentiate between the virtual execution and the legal significance in the real world: A blockchain merely stores information and actions to be executed. However, their execution does not necessarily hold ultimate legal validity in the event of a dispute or arbitration. This means that, at the present time, smart contracts do not automatically serve as evidence in court to prove a certain claim, but require individual verification.

Similar terms

ERC-721-Token (NFT)

ERC-721 tokens are non-fungible tokens (NFT) based on Ethereum.

ERC-20-Token (Smart Contracts)

ERC-20 tokens (also known as smart contracts) are standardized/unified tokens based on the Ethereum platform.

Security Token

A security token (also "equity token" or "investment token") is a cryptographic token that is tied to a value or security.

Cryptocurrency (Currency Token)

Cryptocurrencies (also currency tokens) are encrypted digital currencies such as Bitcoind or Litecoin.