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The Smart Contract Revolution Is Coming

 7 min read / 

It may appear that the cryptocurrency revolution has already taken place, but there is another aspect to the use of blockchain-based technology which could change the world even further. Blockchain and cryptocurrencies are driving groundbreaking innovations in areas such as smart contracts, debt and equity tokens, and employee stock ownership plans (ESOP). The full effect of these innovations has yet to be felt though.

Smart Contracts

Smart contracts are blockchain-based traditional contracts translated into digital code. The digital program defines all the conditions and penalties typically included in a conventional arrangement and automatically executes only when the requirements from both parties are met. While this process has yet to be perfected, this innovation presents numerous advantages over traditional contracts.

Smart contracts have the potential to eliminate the middleman in many scenarios. Typically, lawyers or notaries oversee the signing of necessary documents, realtors and mortgage officials run the transfer of properties between parties, and brokerages or government agencies regulate stock exchanges. Each point in the transaction adds to the cost and possibility of fraud. Based on the blockchain, smart contracts have a very low risk of deception or forgery, and the transfer and verification of assets can take place seamlessly. Go-betweens are eliminated through the use of smart contracts, making the whole process quicker and cheaper.

The decentralised nature of the blockchain means that no one authority holds or evaluates the deal. The whole network is involved in verifying and storing the smart contract, making it very hard to alter without the explicit permission of all parties concerned. When changes do occur, they are stored on the blockchain, making the entire history of the contract available for all parties. Smart contracts offer autonomy, trust, cost savings, efficiency, accuracy, and backups that traditional contracts cannot provide.

Government contracts, transfer of ownership of real estate, cars, or other assets, healthcare records, employment contracts and many others could all stand to gain massive improvements in efficiency and security if executed through smart contracts.

The Blockchain

Smart contracts are still relatively new, and the infrastructure to support them is only starting development. Currently, there are a limited number of cryptocurrency blockchains that support smart contracts. Bitcoin, although the most highly traded cryptocurrency, its ability to process contracts is limited. Though there are side chains which augment this, they are not popular. Ethereum is the leading platform for smart contracts. Through Solidity, its bespoke coding language presents users with a wide range of smart contract capabilities.

Despite the numerous advantages, there are some potential problems with smart contracts. The majority of these weaknesses are due to the technology only emerging recently. Questions about regulation and taxation remain unanswered, and there is always the worry about bugs in the code. The code is law in smart contracts, and potential attackers may spot and exploit any errors or loopholes in the code. Smar contracts may become the future of legal transactions, but it will take time to sort out all the possible issues.

Initial Coin Offerings

Through Initial Coin Offerings (ICOs), startup companies raise capital by issuing tokens (also known as coins) in exchange for cryptocurrency. ICOs allow these companies to forego the rigorous fundraising process which usually includes heavy involvement from banks, venture capital firms, and regulators. Companies can raise millions of dollars in a short amount of time.

The tokens these companies issue are digital assets that can be traded on various exchanges or between individuals. These tokens can be classified into three groups: utility, equity, or debt tokens. One of the differences between the cryptocurrency market and traditional capital markets is the democratisation of investing. There is a high level of diversity in options available to ordinary investors online. This allows regular investors to choose what types of investments they make and the benefits that come along with these.

Different Tokens

Utility tokens entitle the holder to access and utilise the service or product developed by the issuing company. Some examples of well-known names in the utility-token market are Filecoin, Flipcoin, and Storj.

Equity tokens may not allow the holder to access the service of the project, but they do entitle the holder to receive dividends as well as the right to vote on significant company proposals. The exact terms and benefits vary from token to token., but Digix provides an excellent example of an equity token.

Debt tokens are the equivalent of short-term loans and entitle the holder to receive an interest rate on the principal amount loaned to the company. This closely resembles traditional debt instruments issued by companies. The cryptocurrency Steem allows its holders to buy Steem Dollars – which entitles them to a 10% interest rate on their principal investment amount.

Employee Stock Option Plans (ESOPs)

Another application that blockchain could introduce is Employee Stock Ownership Plans (ESOPs). ESOPs, especially in startup companies where revenue is slim, and the compensation packages are mainly stock-based, are an essential part of employee incentivisation. The current structure of ESOPs, however, presents several problems for employees.

The current structure of ESOPs incentivizes employees to stay with the company they work with because the longer they remain at the company, the more options they earn. In Europe, options may usually only be exercised in a liquidity event, such as an IPO. Alternatively, in the US employees may use their options when leaving, but they don’t generate liquidity for their owners until an exit takes place. This makes stock options effectively illiquid.

Because of this, employees remain at a company even when they may desire to leave. Additionally, there is currently no method to accurately value options granted by companies. This has three negative results:

  1. Employees have no idea how employment offers compare to each other
  2. Employees aren’t able to approximate how much they will be missing out on if they leave early
  3. Companies don’t understand how many options they should grant to employees, because of the lack of an accurate market value

The Tokenization Upgrade

The tokenization of employee stock options would involve issuing company cryptocurrency tokens representing options to employees based on blockchain-based smart contracts. As a result, stock options would become liquid. The options, now represented by tokens, may be traded or sold. This would create a whole secondary market for pre-ICO stock options, driving value and diversification for investors in an unexplored fashion.

ESOPs would also become transparent. Tokenizing options provides a way for employees to understand the value of their stock options and allow more straightforward comparison. Since the tokens would be blockchain based, the algorithm and terms of the agreement would be known by the employer and employee. This would allow for employers to incentivise specific behaviours such as loyalty over an extended period or commitment to a company vision early on. There are also legal implications for decreasing or almost eliminating levels of corporate fraud relating to stock options.

The Future

We are only in the early stages of the cryptocurrency revolution. Due to its novel nature, the terms, definitions, meanings, and understanding of these concepts and possibilities have yet to be cemented and are continually changing. Despite this uncertain and uncharted territory, this technology will only become more prevalent and influential in the coming years. Smart contracts are just the beginning of the innovations that cryptocurrencies and blockchain technology will provide over the next century.

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