What are Smart Contracts?

Smart contract is an electronic protocol for enforcing and verifying of transaction as per rules of agreement in a legal contract. Contract is a written agreement between two parties i.e. sender and receiver with a set of agreement relating to achievement of desired performance and service levels. Smart contract was first proposed by Nick Szabo in 1996. It was initially designed by Nick for enabling digital transactions of a stranger on e-commerce platform.

Transaction Cost for a typical transaction comprises of following cost components:

Search and information costs
Bargaining costs
Policing and information costs

Smart contract offers advantage over traditional contract in reducing cost components associated with a transaction. Search or switching cost has internal and external cost components. External cost is the cost incurred in searching for better opportunity in the outside market and is an optional component for involved party. Internal cost is the cost incurred for effort in sorting and segregating the assorted information. Pereira, 2005 advocated that internet allows in reduction of search and information cost. A reduction in search price has a direct bearing on reducing price and price variance.

While bargaining on terms and price, there would be a bid and ask price. Smaller the difference between two prices, there exist higher chances of reaching a consensual agreement. Smart contract with a set of rules triggers the contract upon fulfilment of such rules. Bargaining is a time consuming task and smart contract facilitate in quickly reaching the decision.

Policing and information cost enforces that other party sticks to agreement of the contract. In traditional contracts there are many instances where violation is unnoticed or lead to legal proceedings. Smart contract doesn't allow either party to violate the terms of contract and makes it error proof.

While there are visible benefits in reduction of transaction cost by incorporating smart contracts. Ensuring robustness of the contract from infiltration of hackers is an issue which hinders its wider acceptance. Hacking incident involving loss of venture capital funding on DAO platform is one such instance. In recent times several companies have acknowledged the benefit of smart contract and are planning its use for future deployment. Deloitte put forth benefits of using smart contract in:

(a) Securities trade clearing and settlement

(b) Supply chain and trade finance

Smart contract is paving way for a development that might have significant impact on operations and functioning of various organisation in digital era.