The idea has a touch of science fiction about it: contracts that execute themselves. Human helpers or intermediaries are no longer needed for this type of agreement. Everything runs automatically. Not feasible? Yes, it is! Almost everyone has already been part of such a smart contract – at the gum machine or the ATM. Banks and insurance companies see the future in digital contracts based on source codes. We explain what smart contracts are, how they work, and why they have what it takes to unburden consumers.

What are smart contracts?

The idea of smart contracts emerged in the 1990s, but was never really implemented consistently at the time. It is only now that people are recognizing the potential and are prepared to invest billions in development. It involves contracts that are stored in programming language. Once they have been concluded, neither of the two parties to the contract has to worry about processing them. That is the job of the code. It ensures that the agreement is honored.

Everyone has probably already come into contact with the basic idea of smart contracts. If you put ten cents in a gumball machine and turn the wheel, you get a piece of candy. Unlike at the kiosk, no human being is involved in this action.

The principle behind it is a simple if-then function. When a suitable coin is inserted, the machine releases the product. A second, somewhat more complicated – although still very simple – example is the ATM. When you insert your bank card, and if the PIN is entered correctly, and if the balance/overdraft in your account is sufficient, then the selected amount is paid out.

What can smart contracts do in the future?

These if-then loops can be created for any constellation from any (business) sector. Especially in the financial sector, there are endless possibilities for using smart contracts. Dozens of options are already being mentioned and some of them have already been put into practice. We take up two of the thought processes:

The best-known example on the web is a smart contract for car insurance. The customer signs a contract with the insurance company. A black box is installed in the car, which has been coded according to the terms of the contract. If the customer really steps on the gas, overtakes on curves and endangers others, the black box sends a message on the dashboard: Your insurance premium will increase by 20 percent. Why? Because it was defined that way in the contract: If the customer does not adhere to the traffic rules and the agreement, then he must pay 20 percent more.

Smart contracts for securities transactions are also conceivable and certainly feasible. The customer buys a bond from his bank with a ten-year term and a guaranteed interest rate of 5.00 percent per annum. If the bond is worth more than 1,000 euros at the end of the contract, the investor gets his money back; otherwise, shares are paid out in the equivalent amount.

These key data are stored in the self-fulfilling contract. When the interest payment date is reached, then the interest is paid. If the contract end date is reached and if the value is 1,100 euros, then 1,100 euros are transferred to the account.

Interfaces expand the Smart Contract spectrum

The spectrum of smart contracts can be expanded through additional interfaces that contribute further data. This applies, among other things, to the mail order business by drawing on data from delivery services. If the customer has ordered and if the retailer delivers the goods, then the tracking system reports that a package is on its way, and then the payment is released.

What is now presented here in a relatively simple way requires complex programming. Only then can smart contracts also function and fulfill their task without a so-called intermediary – an intermediate instance. This is where technology and the question of security come into play.

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