Blockchain technologies and smart contracts will be critical to the way we work and trade in the future, including in financial services. Most people who have heard of blockchain know it as the technology that enables cryptocurrencies. But its use in smart contracts will make it much more commonplace, as they are set to gradually change the way the world works.
QY Research predicts the global smart contract market will grow to $1.4 billion in 2028 from $315 million in 2021 – an annual growth of 24%. This is due to growing uptake across a wide range of industries and governmental bodies worldwide.
Blockchain is an immutable ledger technology that facilitates secure transaction recording and asset tracking. Blockchains exist across a network and so are extremely difficult to hack or tamper with as it would require accessing each part of the network.
Smart contracts are programs stored on a blockchain that run when predetermined conditions are met. They are typically used to automate the execution of an agreement so all participants can be immediately sure of the outcome, without any involvement from intermediaries, or time loss. They can also automate a workflow, triggering actions when conditions are met.
A simple case
A simple example of how a smart contract could be used is a book sale. A customer wants to buy a book from an online retailer. Currently, this customer would likely go online and purchase the book. They would transfer money to the online retailer, trusting them to deliver the book. If not, the customer trusts the retailer will refund them.
As in the diagram below, with a smart contract, this purchase would happen in a completely different and decentralised way. No party would have to rely on trusting another, and each party would always have full visibility of funds.
Smart contract use in a book sale
Smart contracts in financial services
This same approach can be taken with an agreement between any service provider and a receiver, including in financial services. Smart contracts provided by a financial institution can act as guarantors to a service provider and receiver, cutting out the many steps a usual service agreement takes. Benefits include removing the need for a guarantor and negotiations and streamlining the approach with guarantor agreements.
Smart contract case – service provider
These are just two cases – the potential number of uses for smart contracts is infinite.
Origin of smart contracts
The beginning of widespread popularity for smart contracts coincided with the 2015 launch of Ethereum – a distributed public blockchain network. It used Solidity, a new language for Ethereum smart contracts.
Some smart contracts have been made using existing languages rather than creating new ones. But Ethereum remains the gold standard for smart contracts. Most other blockchains have their own version, but they generally take the Ethereum smart contract engine and put it in their own blockchain.
Pros and cons of smart contracts
As shown in the cases above, smart contracts allow transparency for all parties. They remove any conflicts of interest because the pre-defined workflows remain independent of all parties using them (providing the smart contract is unalterable – some aren’t). The code is an independent arbiter.
Complex data structures can be represented using smart contracts, enabling financial institutions to represent assets as digital tokens, this includes for bonds and securities.
But smart contracts cannot solve every problem. For example, they cannot complete:
- high-frequency tasks such as foreign exchange trade matching. You could complete this on the blockchain, but you may have lost out by the time it completes
- heavy computational tasks such as independently calculating the on-chain risk of a portfolio
- non-deterministic tasks – for example, when inputting a number, a random number is returned.
Examples of how smart contracts could work in future
Imagine a self-driving car that is represented on a blockchain and can manage its own finances. This car could have a smart contract that represents it and receive jobs such as deliveries and taxi services.
The car could complete jobs and receive payments via smart contracts. It could detect when it needs repairs or fuel and use the money earned to pay for these – including maintenance and replacements – out of that smart contract.
This car’s owner should theoretically never need to get involved in its running or financial management. It could use its own artificial intelligence without any centralised service.
In nations with good systems of trust – mostly the developed countries – smart contracts are an incremental change. In nations where these systems of trust do not exist, smart contracts can provide exponential change:
- providing an identity that can be proven – in the UK, for example, multiple background checks can verify an individual’s identity. But equivalent trusted systems do not exist in many developing countries to complete these checks, and therefore reliable proof of identity is unavailable
- making property transactions faster and more secure – in the UK, the Land Registry provides trusted documentation proving property ownership. But equivalent trusted systems do not exist in many developing countries
- tracking financial transactions without corruption. In a poorer country, the likelihood that businesses could pay off the government with bribes to avoid taxes or to make other financial profits increases.
Removing uncertainty to promote trust
Smart contracts provide trust in a way no human or institution can as they remove uncertainty – there are no surprise elements. Their transparent and independent nature allows for peace of mind for all involved, and they will gradually become commonplace for all of us.
How Delta Capita can help
Delta Capita has an experienced and dedicated team that provides expertise in digital assets and regulatory compliance to many financial institutions worldwide.
This experience gives us an expert view of industry best practices and financial regulations. For organisations impacted by, or interested in, smart contracts, we can provide valuable insights and ensure your firm is always aligned with the latest regulations and licenses.
Contact us to find out more and speak to one of our experts.