By Michael del Castillo,
When Republican President-elect Donald Trump is sworn in as the 45th President of the United States next January, a new era of widespread deregulation is expected to commence.
Bolstered by the support of a Republican-led Congress, Trump has sworn to erase consumer and investor protections that he argues kill jobs in nearly every large regulated industry, from healthcare to energy production to finance — all of which have been targeted for disruption by blockchain innovators.
The problem is, at this early stage of blockchain’s development, the only large-scale implementation of a certain kind of self-executing code believed to hold the biggest potential ended in a total failure.
Earlier this year, countless investors watched helplessly in the hours following the hack of The DAO, a distributed autonomous organization that raised millions of dollars using a framework of by-laws and workflow captured with self-executing code called smart contracts. The DAO had no boss and no oversight.
The promise of blockchain leading up to the The DAO’s collapse was that these and other back-office operations could be coded using ethereum’s distributed ledger, letting investors and counterparties work together without middlemen.
As it turned out though, oversight was needed after all. Functions in the code were exploited to drain The DAO of millions of dollars it had raised, and the only way to stop the loss was for the group behind ethereum to coordinate a massive effort to reset the system.
The very the cryptographic protections that made the code so secure prevented it from being changed.
“Code is law” was the mantra uttered by some of the most extreme advocates of the technology — before the ethereum ‘hard-fork’ rescued investors by undoing what the contract had been tricked into executing.
Now, in the lead up to the expected inauguration of President-elect Donald Trump, huge swathes of the financial sector are experimenting with similar ways to automate a wide range of services using smart contracts and similar self-executing code.
But alongside the transition of power, the process of what it takes to write smart contracts is being reimagined to ensure the chaos surrounding The DAO doesn’t ease its way into mainstream finance.
Evolving blockchains
There are already some novel takes on smart contracts being pursued by the likes of R3CEV and Digital Asset Holdings, which are largely aimed at streamlining inter-bank transactions and post-trade services.
As blockchain companies prepare for the large-scale deregulation across industries, the $7.6bn investor communications firm Broadridge (which spent $95m on blockchain-related assets) is hard at work building its own solution.
Last week, the head of Broadridge’s blockchain team spoke about how to make sure workflows enshrined in blockchain-based smart contracts can be modified after they initiate.
Broadridge global head of strategy and blockchain lead, Vijay Mayadas, said:
“If you have a smart contract which is valid in a particular regulatory regime and it no longer becomes valid, then you have to create a new smart contract, like version two. It will work in a very similar way with some tweaks, relative to version one.”
For developers who have learned lessons from The DAO’s collapse, the transition between these two versions need not be any more dangerous than the transition of the regulatory regimes themselves, according to smart contracts researcher and Cornell professor Emin Gün Sirer.
But for developers who haven’t fully learned the lessons of The DAO, Sirer gave a dire warning of what to expect.
“Smart contracts without escape hatches are like programs without safety checks combined with contracts without arbitration clauses. “Your code will go wrong, your organization will run in ways you did not anticipate, your money will get lost, and you’ll have absolutely no recourse.”
Trumpian business logic
Another way to think about these smart contracts is as the encoded business logic behind work flows.
Once these smart contracts are initiated, their business logic transacts the data and records the results on the immutable, shared blockchain just like any other transaction.
During a regulatory regime change, the composition of that logic needs to be altered to reflect the changing demands for what information needs to be captured and stored, and what information can drift off into the digital ether unrecorded.
But by the very nature of the blockchain, the existing records logged under the business logic of the earlier regime remain unchanged.
“That data was generated in that environment and it’s immutable,” said Mayada. “What will happen is there would be different business logic which would generate that data.”
So far, Donald Trump’s position regarding blockchain development is unknown. But the business logic regulated smart contract developers will be expected to encode is more certain.
Initially, Trump’s tough talk towards the banking industry leading up to his election, helped contribute to bankers largely backing the Democratic presidential candidate, Hillary Clinton, according to a Wall Street Journal report.
But since the election those same bankers have flocked to the President-elect.
Among Trumps deregulation plans he has promised to “dismantle” much of the Dodd-Frank Act that has cost the financial sector $36bn in compliance costs over six years.
Escape hatches
But undoing regulatory obligations in a smart contract world isn’t as easy as deleting the old requirements and adding new ones.
Today, Broadridge has kept secret the details of its work to simplify investor communications, but Professor Sirer argues that key regulatory flexibility will be brought about by technology known as an “escape hatch”.
If Broadridge or any other regulated institution were to initiate a smart contract prior to Trump’s inauguration, escape hatches encoded in the genesis block would help prevent the contract from running out of control, as happened with The DAO.
Sirer breaks down these coded escape hatches into two categories. The first is a centralized escape hatch, which he argues would deprive a distributed system of its value by placing its final control in the hands of a single person or entity.
But earlier this year, he published the specifications for a decentralized escape hatch (DEH) that could help regulated entities to stay compliant with ever-changing demands withoutcompromising the “desirable properties” of a blockchain.
Sirer described such an implementation:
“You must expect your smart contract applications to be updated over time, especially in a system like this when things are known to change in the future. Once you understand this has to happen, building the required escape hatches is just the cost of doing business.”
Money to spend
Currently, Broadridge is only in the earliest days of its smart contract development.
Mayadas said:
His team of 30 is building largely on the ethereum blockchain, with other experiments using the Digital Asset Modelling Language (DAML) created by Digital Asset Holdings (in which his company is an investor), and the Hyperledger consortium, of which Broadridge is a member.
But with $2.9bn in revenue last year from its proxy services and 85% market share in the US, Broadridge could soon be using a blockchain to help global investors communicate in increasingly sophisticated ways.
It is exactly this potential that Sirer thinks is the reason the firm spent that $95m in the first place.
While Mayadas wouldn’t go into details about exactly how the investment is being used to build blockchain applications, the ability to remain nimble in the face of ever-changing demands while still leveraging the benefits of a shared, immutable ledger is central to the company’s investment.
A recently published annual report described the assets acquired from shareholder communications platform Inveshare as giving Broadridge a “dynamic architecture” that will help it “more rapidly develop a streamlined distributed ledger over the next several years.”
Established systems
Fortunately, much of the workflow that financial institutions like Broadridge conduct is already largely established, unlike the DAO.
These established workflows mean that, while Trump moves to appoint members of his cabinet and lay the framework for deregulation, including appointing a new chairman of the Securities and Exchange Commission, there’s plenty work to be done.
According to Tabb Group’s head of FinTech research and the former chief operating officer at NYSE Technologies, Terry Roche, the “tremendous amount of iterations” the workflows have undergone make them ripe to be written as self-executing code.
The trick will be to ensure that the code that is written accurately reflects the workflow itself.
Roche said:
“There will need to be significant rigor, next-generation toolsets that will need to be applied to smart contracts in this environment to understand what the impacts of those code bases will be and I think more importantly, to understand the trees of unintended consequences that could come out of the codebase.”
Smart(er) contracts
In the quest to build smart contracts with escape hatches and perhaps other means of avoiding The DAO’s fate, while capitalizing on their promise, one thing is clear: while less regulation might mean less work for bankers and regulators, the process of changing won’t necessarily be any less time consuming to coders.
Mayadas:
His firm has a “wait and see” approach to seeing “how the new administration deals with the current regulatory environment,” but he gave no indication that the work being done by his team would stop or even slow down.
Sirer supports the idea that there’s no reason to wait, so long as the developers are building escape hatches to avoid becoming cryptographically trapped in an old regulatory structure.
Sirer concluded:
“The building must continue at its current pace for the simple reason that the regulators have a very soft touch at the moment and there’s no reason to anticipate regulators coming into the space with a heavy hand. I don’t see that happening at the moment and I don’t for the next four years.”