Typically, smart contracts are based on distributed ledger technology, such as blockchain — the tech behind Bitcoin. They offer an enticing solution to simplifying many types of business agreements — such as cross-border trade — by enabling actions, such as payment, to be automatically triggered in the event of pre-agreed conditions being fulfilled.
What is it?
Usually based on blockchain technology, a smart contract is a programmable business agreement that allows for automatic execution of actions according to agreed terms. For example, if your goods arrive safely at your trading partner’s warehouse, payment is automatically triggered.
The terms of the contract — for instance, which conditions trigger an action, such as payment — are defined upfront and written into code. This is then stored on a blockchain and cannot be changed without agreement from both parties.
What’s in for you?
Smart contracts potentially enable you to reduce your dependencies on third parties, such as lawyers and intermediaries, when conducting transactions — thereby reducing your transaction costs.
Given the terms of the contract are agreed upfront, with actions defined in code, transactions are both transparent and irreversible. So, hold up your end of the agreement and you’re going to get paid. This should reduce risks, especially in complex transactions as cross-border trade.
What are the trade offs?
While smart contracts aren’t new — the ideas behind them predate Bitcoin — they are typically based on blockchain technology. And this is unfamiliar territory for many enterprises.
The complexity of implementing smart contract technology in a secure, scalable, reliable environment should not be underestimated. In many cases, those organizations that have explored smart contract implementations have concluded that the risks currently outweigh the benefits.
How is it being used?
Distributed ledgers and smart contracts will become more common as globalization continues to increase. For example, companies that have distributed manufacturing, sales, engineering, marketing and customers and need to manage dynamic and differentiated tax policies, may get 'stuck' trying to use a traditional ERP. They could use smart contracts and a distributed ledger to 'allocate' the revenue around the world in order to support this.
If an interesting accounting model can help business profitability or competitiveness, smart contracts may help.