Paper contracts can take weeks to travel around the globe, while digital documents are uncomfortably easy to forge. Is there a way to automate transactions to make them smoother, more efficient, and more secure for all parties? Leaders are looking at blockchain and smart contracts as a viable solution.
Blockchain technology is generating significant interest across a wide range of industries. As the field of applications for blockchains grows, industry leaders are customizing and tailoring the technology to fit very particular uses. Blockchain-based smart contracts—self-executing code on a blockchain that automatically implements the terms of an agreement between parties—are a critical step forward, streamlining processes that are currently spread across multiple databases and ERP systems. Smart contracts in the commercial realm have not yet been proven, but we believe that permissioned blockchains (those that are privately maintained by a small group of parties) in particular will find near-term adoption. Two blockchain-based smart contract use cases—(1) securities trade clearing and settlement and (2) supply chain and trade finance document handling—carry important lessons for business and technology leaders interested in smart contract applications.
Smart contract VC-related deals totaled $116 million in Q1 of 2016, more than twice as much as the prior three quarters combined and accounting for 86 percent of total blockchain venture funding
An Ethereum-based organization has raised over $150 million to experiment with and develop smart contract-driven applications.
- The Australian Securities Exchange is developing a blockchain-based post-trade solution to replace its current system
- The Post-Trade Distributed Ledger Group, an organization launched to explore post-trade applications on the blockchain, has 37 financial institutions as members
- Five global banks are building proof-of-concept systems with a trade finance and supply chain platform that uses smart contracts
- Barclays Corporate Bank plans to leverage a smart contract bill-of-lading platform to help its clients reduce supply chain management costs
- The state of Delaware announced initiatives to utilize smart contracts for state-recognized “distributed ledger shares” and to streamline back-office procedures
WHAT ARE BLOCKCHAIN-BASED SMART CONTRACTS?
Smart contracts represent a next step in the progression of blockchains from a financial transaction protocol to an all-purpose utility. They are pieces of software, not contracts in the legal sense, that extend blockchains’ utility from simply keeping a record of financial transaction entries to automatically implementing terms of multiparty agreements. Smart contracts are executed by a computer network that uses consensus protocols to agree upon the sequence of actions resulting from the contract’s code. The result is a method by which parties can agree upon terms and trust that they will be executed automatically, with reduced risk of error or manipulation.
Technology leaders envision many applications for blockchain-based smart contracts, from validating loan eligibility to executing transfer pricing agreements between subsidiaries. Importantly, before blockchain this type of smart contract was impossible because parties to an agreement of this sort would maintain separate databases. With a shared database running a blockchain protocol, the smart contracts auto-execute, and all parties validate the outcome instantaneously and without need for a third-party intermediary.
But when should companies employ blockchain-enabled smart contracts rather than existing technology? They can be a worthwhile option where frequent transactions occur among a network of parties, and manual or duplicative tasks are performed by counterparties for each transaction. The blockchain acts as a shared database to provide a secure, single source of truth, and smart contracts automate approvals, calculations, and other transacting activities that are prone to lag and error.
BLOCKCHAIN-BASED SMART CONTRACT BENEFITS
For a wide range of potential applications, blockchain-based smart contracts could offer a number of benefits:
Speed and real-time updates. Because smart contracts use software code to automate tasks that are typically accomplished through manual means, they can increase the speed of a wide variety of business processes.
Accuracy. Automated transactions are not only faster but less prone to manual error.
Lower execution risk. The decentralized process of execution virtually eliminates the risk of manipulation, nonperformance, or errors, since execution is managed automatically by the network rather than an individual party.
Fewer intermediaries. Smart contracts can reduce or eliminate reliance on third-party intermediaries that provide “trust” services such as escrow between counterparties.
Lower cost. New processes enabled by smart contracts require less human intervention and fewer intermediaries and will therefore reduce costs.
New business or operational models. Because smart contracts provide a low-cost way of ensuring that the transactions are reliably performed as agreed upon, they will enable new kinds of businesses, from peer-to-peer renewable energy trading to automated access to vehicles and storage units.
SMART CONTRACT USE CASES
To determine high-impact areas of potential, Deloitte’s analysis of smart contract use cases considered a number of factors, including: a sizable market opportunity; the presence of active, relatively well-funded start-ups targeting the opportunity; the participation of prominent investors; technical feasibility and ease of implementation; and evidence of multiple pilots or adoption by corporations. The lowest-hanging fruits today are applications in which contracts are narrow, objective, and mechanical, with straightforward clauses and clearly defined outcomes.
We have identified a range of applications—ranging from smart health records to pay-as-you-go insurance—that companies are piloting right now (see table). Using the criteria above, two use cases stand out for their immediacy to market: trade clearing and settlement and supply chain and trade finance.