Get Smart with Your Contracts

ISE Magazine, Volume: 50, Number: 5
By Gurram Gopal, Alejandro Garach Martinez and Juan Martinez Rodriguez

Blockchain technology is enabling business value advancement in everything from manufactured goods to online music
Cryptocurrencies, particularly bitcoins, grabbed major headlines in 2017, with bitcoin value going from 6 cents on July 19, 2010, to $19,343.04 on Dec. 16, 2017. While the long-term value of these digital currencies remains to be seen, the underlying technology of blockchains has the potential to revolutionize many industries. This article addresses one major application of blockchain technology: smart contracts.

How do blockchains work?
Blockchain technology – a distributed approach. The central characteristic of blockchains is that copies of a ledger of transactions are “distributed” and validated by a consensus method in which numerous users independently verify that accounting modifications are valid, thus eliminating the double spending problem without the need for a central overseeing authority like a central bank. The operation of a blockchain requires multiple transaction processors (miners), full ledger hosts (full nodes) and signatories (wallets). All hosts hold identical copies of the ledger. An example of this application is the bitcoin, where transfers between payer and payees are effectively conducted without credit risk or liquidity risk inherent in the bank-driven fiat system. The underlying technology can deliver a broad range of benefits across the full capital market value chain, from clearinghouses and exchanges to prime brokers. The benefits may include:

  • Faster clearing settlement: Once a transaction is confirmed, the associated token also is delivered to the beneficial owner. A fast settlement reduces costs and lowers counterparty settlement risk and fraud.
  • Ledger consolidation: With legal entities acting as full nodes, proprietary ledgers based on various regulations can be combined into a single model for reporting purposes.
  • Consolidated audit trail: There is a precise asset history with a record of movements that is transparent for the parties.
  • Reduction in systematic risk: Distributed ledgers virtually eliminate credit and liquidity risk by requiring pre-funding prior to trading.
  • Operational improvements: A number of middle- and back-office processes are eliminated.

Blockchain and the fourth industrial revolution. The fourth industrial revolution, also called industry 4.0, refers to the collection of new products and processes driven by digitization and the development of the modern internet along with the internet of things (IoT). The following developments are often included in this paradigm:

  • Smart buildings: The development of smart buildings based on networkenabled sensors and building automation systems will play a key role in our future, increasing energy efficiency while making us more productive.
  • Digital manufacturing, including additive 3-D printing: Manufacturing is undergoing enormous change as additive manufacturing continues to gain ground and costs come down. Rapid improvements in 3-D printing now allow even individual and small job shops to turn out parts and finished products and compete with established manufacturers.
  • Data mining: As businesses collect enormous amounts of information on their customers, suppliers, employees and equipment, the fourth industrial revolution underway will result in companies using this information to make more intelligent business decisions.

There are numerous synergies that can be gained by combining these advances with the rapid developments in blockchain technology.

A smart contract is a type of process that can be automated and set to trigger when certain binary factors are met.

By automating and enhancing the contracting procedure through programming, these contracts enable performance monitoring and enforcement of contractual assurances without human involvement. This automation could have several benefits, including lower operating costs, reduced errors and more effective dealings. For example, the automatic verification of a contractor’s work could allow the contractor to be paid more quickly and prevent delays.

The functions, once written, can be used in a variety of applications. There are thousands of script codes already written with potential uses in new voting system platforms, the automotive industry, real estate, the financial system, supply chains and many other areas. Contracts could be drawn up and executed without lawyers or courts. Property could be transferred and verified by the blockchain without real estate agents.

Smart contracts have the potential to reduce significantly the need for litigation and courts. By using a smart contract, parties commit themselves to be bound by the rules and determinations of the agreed code.

Tracking pallet movements

While most of the recent blockchain activity in the supply chain area has been focused on tracking high-value items like diamonds and nuclear material, we have examined the potential for its use in tracking pallets, working with a company specializing in pallets of various types. The company’s pallets move many products across nearly every supply chain. The pallet pooling system allows companies along the supply chain (retailers, manufacturers and producers) to use pallets jointly to save cost and reduce the damage of the freight along the supply chain. Once a client does not need the pallets anymore, the company is notified and collects them. Unfortunately, the company does not have visibility into its pallets until its customers or partners stop using them. The time between the initial use and its collection can range from a few weeks to years.

Provenance model. Provenance is a decentralized application (Dapp) that uses a blockchain to execute specific business rules and enables the tracking of physical goods. According to a white paper by Project Provenance Ltd., Provenance can provide every physical product with a digital “passport” that establishes authenticity, quality, quantity and origin. This creates an auditable record of a product’s movements that is recorded in the blockchain network.

Application. In this case study, the product is a pallet that has a digital identity (through RFID, QR code or barcode) that allows for tracking. The identity is linked to a digital cryptographic identifier, and the location will be updated during the product lifecycle. The various players involved in the supply chain, called actors, will register themselves in the network. An accreditation service provides them unique identification credentials involving a public key and a private key. Each time an actor makes a change it is recorded as a block.

In the pallet network, the actors include product producers; goods manufacturers who initially procure the pallets; distributors and retailers; recycling and waste management organizations; insurance companies; standards organizations; and certifiers who ensure that the actors are valid, thus allowing them to participate in the network. Each actor has its interface to access the system. The data collected by the system and linked with each product includes ownership data, showing the current owner as well as the history of prior ownership.

The set of rules governing product movements and related activities are defined in a smart contract implemented in the Provenance model in a blockchain network such as Ethereum. This contract allows programmable code to be executed, enabling a set of activities based on triggers like product ownership change. In the future, this same Provenance system can also include reverse logistics activities, including repair, warranty recovery, redistribution, remarketing, end-of-life recycling or any combination of these activities.

Making music sing

Online streaming music services like Spotify and Pandora report users in the millions but have a difficult time converting them into profits. The reason to consider implementing the smart contract and the blockchain in the music industry is to rethink the music’s value chain and the current business model. The internet had a great impact in value creation, especially in culture-related industries. Further, there is a transformational shift from value creation to value co-creation, which is fundamentally changing the relationship between consumers and producers. In addition, the internet is enabling some record labels, musicians and fans to work together to co-create valuable products for mutual benefit.

Potential uses. Blockchain networks with smart contracts have the potential to restructure rights and royalties systems in the music industry. There are a number of startups, including Ujo Music and Voise, that use blockchain technology to allow musicians to monetize their work, manage their rights and accept peer-to-peer payments. A song streamed by a user triggers a smart contract that will make an instant payment to the artist, songwriters or rights holders. In addition, it also allows the participants to gather, store and analyze useful consumption data.

These types of applications could negatively affect established leaders in the industry as consumers would rather use a transparent, fair payment method for their music. The failure of major labels to adopt disruptive technologies suggests a refusal to create an extra value for music in the techno-culture society that is developing. Instead, they have focused on creating a revenue stream from the copyright licensing and music playing. But the artists would prefer an application or environment where they could engage in a new relationship with their fans, receiving transparent feedback on their work. A new ecosystem based on a platform supported by blockchain’s smart contract with the collaboration of the music community will enable contracts based on integrity, transparency, security and respect of rights in the industry.

Collateral benefits. The smart contracts have the potential to treat the artists as entrepreneurs and also as partners. The transparent distributed ledger of the blockchain will expose the distribution of revenue generated on a song. It can be automated as a micropayment in which the streaming of any song will immediately distribute the revenues according to the percentages predefined in the smart contract.

Another important consideration of the technology is the transformation of the current database of copyrighted material (lyrics, recordings, etc.) that the artists are willing to license for further use. The availability of such a database will increase the opportunities for other forms of licensing. Data analytics can help the community of artists develop the best strategy in terms of sponsorship and marketing as well as further creative collaborations with other artists. This is one of the drivers behind the open music movement started by the Berklee College of Music with the support of various members involved in the industry.

Digital rights management is automatically enforced by the smart contract, which includes clauses regarding the relationship with record labels and distribution services. For example, artists could demand to eliminate any ads in the streaming of their music. Artists and labels have the ability to set some limits like the termination of the contract if the revenue doesn’t reach a certain amount. Any time rights management is enforced in a deal, the participants are automatically notified.

Dynamic pricing models are valuable in the music industry, as there is significant uncertainty in the demand for a new album or a song. The ability to modify the prices and the royalties dynamically depending on the achievement of some goals will enable more value to be generated from the music.

Social network promotion can be accomplished as the bitcoin ledger could be connected to social media so that when a transaction occurs, like a new single being released, it could be promoted through social media applications.

Akin to bitcoins or ether, artists could accept “musicoins” as an exchange for downloading their music. Such cryptocurrencies would enable more transactions involving music and generate more value in the music chain.

Cooperation is the key

Realizing the full potential of smart contracts in any industry depends on the cooperation among market participants, regulators and technologists, and this may be the major challenge for widespread adoption of blockchain-based smart contracts.