A smart contract is based on computer protocols. It is therefore a type of digital contract based on blockchain technology. The terms of the agreement between "buyer" and "seller" are written directly in lines of code. Smart contracts are self-executing contracts, which means that they come into effect independently when certain predefined events occur and therefore do not require human monitoring. If these entry conditions are met, the algorithm automatically initiates a transaction, which is then validated and stored in a block. Smart contracts thus enable the execution of trustworthy transactions and agreements between different parties.
Probably the best-known blockchain platform for developing these digital contracts is Ethereum.
Smart contracts are internet-based contracts whose contract terms are determined by means of a programming language. After the contract has been concluded, it checks continuously and independently. Once this is the case, the other part automatically fulfills. This promises fast and cost-efficient contracts that mean significant added value.
For example, automated sales contracts could be concluded in which payment is automatically instructed when the post office has successfully delivered the package containing the goods.
Insurance contracts could also be at least partially automated in this way. For example, the Blockchain Insurance Industry Initiative (B3i), which consists of several major insurers, is considering automatically paying out the contract amount of a natural hazards insurance policy if an earthquake or flood occurs at the location of the insured building.
Multiple smart contracts can also be combined so that they are mutually conditional or mutually exclusive. This creates completely autonomous decentralized companies, such as.
- Uniswap (decentralized cryptocurrency exchange) or
- MakerDAO (Stable Coin DAI).
Smart contracts are not the only possible use for Ethereum.
- The Ethereum blockchain allows its users to create their own digital tokens. These tokens, in turn, can be linked to a smart contract. This makes it possible, for example, to securely track ownership of real-world goods via a blockchain. This is particularly useful for rare and expensive goods such as diamonds, art or gold bars.
- Government registers can also be replaced by digitized assets. Examples of applications include the patent register or the land register. Instead of a time-consuming process in front of a notary and the land registry, the transfer of ownership of a property would only take seconds.
- Financial instruments are also predestined to be virtualized on the Ethereum blockchain. For example, a company could issue bonds or participation certificates as digital tokens. Investors could then subscribe to them and trade them just as easily as on the stock exchange. Via smart contract, they could also be programmed to automatically pay out their coupon to the respective owner. Even the exercise of voting rights via the blockchain (with so-called governance tokens) would be a conceivable option. Especially for smaller companies that want to finance themselves via crowdfunding, Ethereum thus enables a fast and cost-effective option without having to register on an exchange beforehand.
Other possible areas of application for Ethereum are the exploitation of rights and use in the Internet-of-Things.
- In the area of rights exploitation, there are still so-called licensing and collecting societies. Artists can register their works with these societies. These societies then take over the licensing of the works and the distribution of the royalties. The system by which the money is distributed is sometimes difficult to understand and has recently been the subject of several court cases. If rights exploitation is handled via the Ethereum network, these middlemen could be eliminated and artists could receive the royalties to which they are entitled directly, transparently, and comprehensibly.
- Ethereum could also become the global enabling technology for the Internet-of-Things. When automobiles, lamps, refrigerators and door locks communicate with each other, it requires a language that everyone understands. Ethereum, as a hardly manipulable, interference-resistant and fast network, has the potential to become this common interface with its Layer 2 developments.
A DAO is a collection of smart contracts that are executed independently and autonomously. There is no general manager or supervisory board that manages a DAO. It only has investors, who receive digital tokens from the DAO against payment of a contribution. These tokens carry voting rights, so that investors can vote on the organization's future actions.
A DAO is not a natural person and not a legal entity, either, since it is not recognized as such by any legislator. Under German law, they could best be described as a partnership under civil law. This type of company arises when several persons pursue a common purpose. As a consequence, all investors of a DAO would be its shareholders. Since a partnership under civil law has legal capacity, it could effectively enter into contracts and even sue and be sued.
The classification of the DAO as a partnership under civil law would mean that all investors would be directly and unlimited liable for the company's liabilities, irrespective of the investors personal investment in the DAO.
As exciting and multifaceted as this new technology is, existing laws are currently not fully capable of covering all possibilities. There are still all kinds of pitfalls lurking here that need to be carefully avoided.
For example, anyone wishing to issue financial instruments via Ethereum will have to comply with banking supervisory law. In the case of smart contracts, the question arises as to which civil law standards apply and how these contracts will be interpreted if they do not work as planned due to a programming error. If property is to be transferred via the blockchain, the peculiarities of property law must again be taken into account.
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