What 2016 Taught Us About Smart Contracts

Cryptocurrencies, tokens, blockchains, smart contracts: I present the delightful panoply of distributed ledger technology (DLT) buzzwords that have been a part of nearly every FinTech discussion for the better part of two years.

Sure, many are tired of the hype and prolonged implementation timelines, but changing how the industry thinks about money and agreements deserves time to grow and develop. Thus, we’re long all things DLT in the year ahead. But first, a few thoughts on lessons learned in 2016.

Without a doubt, smart contracts have dominated most DLT conversations in financial services.

My firm’s public projects focused on building smart contract networks for OTC markets. Our goal was simple: identify asynchronous contract workflows and perform those workflows synchronously across a network of provisioned peers.

In two proofs-of-concept (PoCs), we commoditized authentication, warehousing and basic event processing for credit default swaps and equity swaps. Our success was driven by close collaboration with industry participants.

Admittedly, the path to completing the PoCs was not as succinct as those few sentences above.

PoC beginnings

We started scoping our smart contract efforts in the summer of 2015, a time when the mantra was, “I blockchain, therefore I smart contract”.

At that point, most enthusiasts were coming to terms with all the shortcomings of bitcoin-esque models (colored coins, “tokenization”, etc). Ethereum, still finding its way, was considered the progressive alternative and logical next step for industry-wide blockchain projects. Self-executing agreement terms seemed appealing (if a tad ominous sounding?) in that they captured the most basic desire in financial services: make banking operations as highly efficient as possible.

Smart contract projects operated under the premise that counterparties simply needed to encode: a) the circumstances under which each party should be paid, b) the information that changes the payment amount, and c) the times at which these payments will be completed. Put it all on a blockchain and problem solved.

This premise wasn’t entirely untrue, and the derivatives world seemed a perfect testing ground given the focus on better managing a), b) and c) via clearing and margining rules.

Lessons learned

But, as is always the case, the devil is in the details. Scoping these proofs-of-concept proved tedious. In hindsight, the scoping exercise alone was valuable because it brought multiple industry participants around one table to collectively realize that smart contracting is hard.

We learned three important things:

1. Agreements are not assets. It seems obvious today, but the distinction could have been better appreciated earlier on. Atomic asset transfer via a peer-to-peer network, akin to the bitcoin protocol, is a fundamentally different proposition than the distribution of the bespoke work of contract management across market competitors. Our fascination with fast and cheap settlement morphed into a focus on information synchronization and data integrity. All good things, but very different requirements.
2. We have a workflow problem, not a technology problem. Contracts are not monolithic “products”. Rather, contracts are the result of a number of discrete functions; creating, legalizing, storing, and enforcing agreements are just a few examples of very different business processes that combine to form the notion of a singular contract. Some of these processes are unique to a firm, while others are managed by industry utilities, while others are value-added services provided by third parties. Smart contracts aren’t necessarily a replacement for any of these as much as they are the platform on which these processes can interact in a less costly and more agile environment.
3. We are building a big tent. Making contracts smart is not achieved with DLT alone. The industry does itself no favors to consider DLT as the singular lynchpin of smart contract success. When we look at DLT as a tool in the toolbox of automation, smart contracts make more sense in terms of business applicability. DLT is all the more compelling when put alongside machine learning, artificial intelligence, and the host of other technologies that allow multiple parties to digest precisely the same information in the same way at the same time.

What we learned helps temper our itch to boil the ocean. Nevertheless, in the spirit of the holidays, the industry should be grateful for the progress it has made – let’s use these lessons to propel us forward.

Ahead to 2017

2017 will see peer-to-peer contract management systems in production. For use cases that were borne out of successful proofs-of-concept, development should move at a healthy clip. New use cases for different asset classes and more bespoke contracts will not be without their unique set of challenges.

The ability for smart contract providers to distinguish the processing elements (ie: smart contract components) of a contract from the bargaining elements (ie: discretionary and human components) of a contract will determine the adoption curve in capital markets.

Beyond smart contracts, we should expect to see renewed interest in the creation of digital assets. Every asset that is committed to paper can exist in a natively digital world. Legal and regulatory ramifications of such a development aside, digital assets can shift the conversation beyond cost savings and into new revenue opportunities and new markets.

Last but certainly not least, we should all keep an eye on “public” blockchain networks.

Bitcoin is still moving value across the world without a hiccup. While bitcoin, ethereum and new networks that develop in the years ahead may not be purpose-built for financial services, the assets and agreements they maintain are new markets and new business opportunities.

Take advantage – the sky’s the limit.