Smart contracts and their use in business

What is DeFi?

Decentralized Finance (DeFi) is an open-source system based on blockchain, cryptocurrency and smart contracts technologies, forming an alternative to the traditional financial system. DeFi offers financial products to users without intermediaries such as banks and exchanges.

It is important not to equate DeFi and cryptocurrencies. Cryptocurrency is built using blockchain cryptography with decentralized, and sometimes anonymous, currency. It is a currency or an asset and serves as the foundation on which the system of decentralized finance (DeFi) is built, following the same principles as those of cryptocurrency. DeFi’s concept focuses on stabelcoins – cryptocurrencies backed by an organization or tied to a fiat currency such as the dollar.

DeFi aims to move the financial transactions we are used to from the fiat world to the digital world using only computer algorithms to do so.

Financial products and services can be programmed on a blockchain, and participants can interact with each other, eliminating the intermediary financial institutions that have traditionally provided these services.

How does DeFi work?

DeFi uses cryptocurrencies and smart contracts to provide financial services. These services include lending (where users can borrow their cryptocurrency and get interest in minutes instead of once a month), getting instant credit, saving cryptocurrency and getting a higher interest rate than a bank, etc.

To facilitate P2P transactions, users use dApps, most of which can be found on the Ethereum network.

A decentralized application (dApp) is a type of distributed, open-source software application that runs on a peer-to-peer (P2P) blockchain network rather than on a single computer. DApps look similar to other software applications that are supported on a website or mobile device but support P2P.

The decentralized nature of dApps means that once the developer has released the dApp codebase, users can use and augment it. The app is free from the control of a single authority.

Some of the most widely used DeFi services and dApps include DeFi mining (aka liquidity mining), Yield farming, trading, and borrowing, lending, and saving with smart contracts.

DeFi is open source, which means that protocols and applications are theoretically open to user inspection and innovation. As a result, users can mix and match protocols to unlock unique combinations of capabilities, developing their own dApps.

Cryptocurrencies use blockchain technology for decentralized financing. Blockchain is a distributed and secure database. Transactions and transactions in the blockchain are performed using decentralized applications (dApps).

Each blockchain contains information about a transaction verified by other users. Once agreement is reached between these verifiers regarding the transaction, the block is closed and encrypted; a new partnership is created with information about the previous block. The information in each subsequent block is linked together to form a blockchain, hence its name. It is impossible to change the information in previous blocks without affecting subsequent blocks, so the blockchain cannot be changed. Together with other security protocols, this concept contributes to its essential security.

Using your decentralized financial app (dApp), the DeFi app will match you with the appropriate lenders that meet your loan needs. The lender’s terms must then be matched, and the loan is processed.

The blockchain records the transactions, but you won’t receive a loan until the transaction is verified from both sides and recorded on the blockchain. The lender can start charging you at agreed-upon intervals. Whenever you make a payment through the dApp, it goes through the same procedure on the blockchain; the funds are eventually transferred to the lender.

Smart Contracts

The technology and principle of smart contracts were developed 10 years before bitcoin was created, but with the development of blockchain, they became more widely used. In fact, the whole essence of smart contracts is based on the “If-Then” system.

Today, smart contracts are small computer programs that have been implemented in blockchains such as Ethereum and Tezos. Smart contracts consist of code and data. The code – essentially a set of functions – can manipulate the data that is stored with the contract. This allows smart contracts to create and manage NFTs and other types of tokens on their own.

A cryptocurrency payment is made to obtain a model contract, after which it becomes available to all parties. The parties can update the contract by mutual agreement before it is executed, and the changes will be reflected in the distributed ledger.

Then, once the contract is agreed upon, the idea of “automatic actions” can be used to enforce the contract (for online actions). For example, when renting an apartment, a digital key can be issued in exchange for a deposit and payment for the first month’s rent. The block will record that if payment is made before date “x”, the key will be issued on date “x”. If the tenant pays the deposit three weeks early and then the owner or tenant changes his or her mind, there is no refund or termination. The “if-then” clause is triggered and will happen regardless of other factors, so the key will be transferred regardless of either party’s wishes.

It is important to note that the smart contract code cannot be changed once it is deployed. Once a piece of smart contract code has been added to the blockchain, there is no practical way to stop or remove it. The code runs autonomously, forever. The smart contract data can be updated and changed. But even when that data is updated, the old version is still preserved-the data updates are included in the blocks of the blockchain, so old versions of the data can be found by looking at the previous chain.

Practical application of smart contracts in your business:

Smart contracts and the financial services industry

Most sectors are beginning to adapt smart contracts into their systems because of the clear operational benefits.

Here are some of the ways and processes in which banks and other financial institutions are using smart contracts.

Reducing Transaction Costs 

Smart contracts reduce transaction costs, as well as making record-keeping easier, and greatly reduce human intervention in the process.

Two different blockchain protocols fulfill this role.  The stellar network and the ripple network; one is more centralized than the other, but both provide similar services for international money transfers through established and emerging financial institutions, allowing funds to be transferred in real time along with minimizing transaction costs, rather than the high prices and days of traditional banks.  They even increase the functionality of smart contracts, making money transfers such as letters of credit possible.

Improved KYC processing.

The customer identification process is now handled by blockchain-based smart contract solutions such as KYC-chain.  Individual parts of the KYC process, such as identification and credit score verification, can be saved and recalled using blockchain records.

P2P transactions. 

Smart contracts on distributed blockchains eliminate the need for a third party intermediary in the form of a bank.  This reduces costs and can simplify transactions for people who don’t even have bank cards.  The slow adoption of cryptocurrencies by retail merchants (various stores) is gradually creating a payments network.  Smart contracts are very profitable for most payments, especially international payments. An example of such a payment would be a recently recorded $1.1 billion transaction between two wallets, but the value of that transaction to the sender was only $80.

Mortgage

Smart contracts can ensure that lenders and loan applicants agree to clear terms, such as proof of funds and payment scheduling. This evolving technology can validate mortgage transactions without the need for third parties.

Digital Identification.

From reputation data to digital assets, you can store smart contract components to form a digital identity. For example, MyEarth ID is a decentralized identity management system that allows users to control their digital identities and securely verify them with third parties.

Benefits of smart contracts

Numerous smart contract applications already exist in industries such as finance, gaming and healthcare. Allowing parties to securely automate and digitize the execution of their normal contracts.

Simplifying

Smart contracts use automation in the process of fulfilling contractual obligations, resulting in greater efficiency. Using pre-configured terms and conditions, smart contracts can facilitate faster deals within minutes.

In addition, real-world examples of smart contracts on the blockchain show how much easier smart contracts are than conventional contracts. Less paperwork, shorter wait times and fewer steps to enter into a contract can all be advantages.

Security

Smart contracts increase security, data protection and privacy through encryption, blockchain cryptography and the inability to identify the user. In addition, smart contracts have the potential to provide greater accuracy, trust and transparency at the same time that they offer a single, shareable and secure copy of the contract.

Problems with smart contracts

The problems of smart contracts are mainly related to their digital nature and the “if-then” model when it comes to real-world situations.

The first problem is that, as with any coded software, bugs can get into the code and cause unexpected problems.

The second problem is the limitations associated with the nature of these contracts. To begin with, cryptocurrencies are now required as a payment method. They are notoriously extremely volatile, which can create differences in exchange rates.

In addition, the automatic execution of digital “if-then” clauses can create problems in real life.

There are times when a party wants to terminate a contract – for example, if it learns that the contractor it hired lied about the amount of work needed and significantly inflated the price. The contract continues regardless of this new information. It cannot be terminated in court or elsewhere.

Equally, there may be situations where the contract must be changed due to changed circumstances. For example, if payments were conditioned on the timely completion of major milestones, and there were financial penalties for late work, and then the scope of work changed. Both parties could agree to extend the deadlines, but payments would automatically be made based on the original terms of the contract, so they could not be changed. The parties would have to agree to make payments within the terms of the contract prior to completion of the work, or create a supplemental agreement outside of the contract to pay any amounts withheld by the contract’s automated payment system.

There may be cases where there was an error in the original contract but it was not noticed before it was executed. Both parties know there is an error in the contract, but are powerless to change it. This can also lead to the need for additional contracts to correct the actions committed in the first contract.

Smart contracts make work easier and cheaper when everyone agrees and the terms of the contract are followed as planned. However, when problems arise, their strength becomes a weakness. As long as that problem remains, even if smart contracts are adopted, they are unlikely to eliminate the need for lawyers – instead of drafting contracts, lawyers may find themselves in a situation where smart contracts don’t work for the parties involved and will negotiate additional agreements and workarounds.

Conclusions

Technology today is developing very rapidly and blockchain is no exception. Blockchain is no longer a system through which users can only transfer funds. Today, thanks to this technology, we see projects that are designed to simplify and replace long-accustomed operational processes, gradually being introduced in all areas of human activity, even those where their use seemed little possible.

In this article we have described only a small part of all opportunities of decentralized finance: such as:

• Personal data protection.
• Optimization of paperwork
• Streamlining, speeding up, and making transactions cheaper

However, this is only a small part of how blockchain in general, and DeFi in particular, can simplify the life of both the average person and business.

Of course, wider use and acceptance requires time and national adoption. But even today, these technologies can make everyone’s life much easier.