Significance of Smart Contracts

Smart contracts are computer programs that facilitate and automatically execute pre-established agreements once certain conditions are met. Popularized by their applications on the Ethereum blockchain, smart contracts enable transactions to be carried out without the involvement of a central intermediary. Compared to traditional agreements, smart contracts are validated across a blockchain’s many nodes, preventing tampering. Their ability to lower administrative overhead, transaction costs, and fraud risks makes smart contracts one of the most attractive features of blockchain technologies. However, there are some downsides: there is no room for error, and faulty terms can lead to improper use of the contracts.

With the blockchain acting as a database, a smart contract implements conditions similar to how a traditional “if/then” program would. The insurance industry stands to benefit significantly from these automated agreements. For example, in the aftermath of a natural disaster like a hurricane, insurance companies are inundated with requests for payouts, which can take months to process. With smart contracts, claims could be processed instantly. The program could sort claims into different categories, allowing funds to be sent automatically to those with simple or easily verifiable claims. To ensure proper responses to all potential scenarios, extensive “if/then” conditions must be in place. Detailed recordkeeping, ownership over items like houses and cars, and financial transactions between insurers and clients stand to benefit greatly from smart contract adoption.

Though smart contracts are likely to revolutionize the insurance industry in the coming years, several barriers to mainstream adoption remain. Key impediments include the upfront costs of creating and integrating transaction platforms, a lack of public trust, the need for human mediation in nuanced insurance sectors, and a lack of comprehensive regulation.

Smart contracts also have the potential to revolutionize home ownership and insurance in developing economies. In terms of home ownership, smart contracts can enable more secure and efficient property transactions by reducing the need for intermediaries like lawyers and real estate agents—who pose a significant barrier for underprivileged groups. Smart contracts can also automate payments for rents, mortgages, and other fees associated with property ownership, reducing the risk of missed payments and contributing to a stable housing market. By increasing transparency and reducing fraud risk, smart contracts strengthen the relationship between buyers and sellers, decreasing the likelihood of disputes or legal challenges.

In the insurance industry, smart contracts can reduce administrative costs, thereby increasing accessibility. By utilizing blockchain to automate claims processing and reduce the need for intermediaries, smart contracts can increase the speed and efficiency of insurance payouts.

The insurance industry is vast, encompassing sectors like real estate, transportation, and health, but it often suffers from a lack of trust among stakeholders. According to polls by YouGov in the U.S., 43% of Americans distrust insurance companies. Smart contracts can help restore trust by reducing fraud through blockchain’s decentralized and open nature. Since any changes to an insurance smart contract are visible to all parties, inconsistencies are minimized. Smart contracts also improve efficiency by reducing the need for intermediaries, as these contracts are fully automated.

Another benefit of smart contracts is their ability to protect policy documents by storing them on numerous ledgers, making them harder to lose. Most importantly, they allow insurance companies to verify claims seamlessly and assess customer risk, as blockchain-based ID systems can automate this time-consuming process. Particularly in an era where cybersecurity is crucial, smart contracts make unauthorized modifications challenging, as each record is connected to previous and subsequent records on a distributed ledger, making it difficult for hackers to alter the chain.

On March 14, 2023, the EU Parliament voted to require smart contracts to include a “kill switch” to reset activity. This decision responded to the 2022 European Union Data Act, which establishes common rules for data-sharing contracts and allows public bodies to use enterprise-held data when necessary. In IT, a kill switch can shut off a device, network, or software in response to a security threat. In smart contracts, it can destroy the contract or pause, patch, and re-release it in the event of a major bug or breach. Critics find the kill switch concept concerning, as it contradicts the fundamental principle of smart contracts, which is that they should be immutable and decentralized. While blockchain continues to evolve and adapt to various needs, the future of this field remains uncertain. However, it is clear that regulation of such technology will become increasingly important and may ultimately determine the success or failure of blockchain.

Authors: Ashika Kanchanakuntla, Manya Kodali, Dagny Whall