Smart contracts are creeping into the news and into financial jargon. Make sure you're up-to-speed on their applications and features.
So what exactly are smart contracts?
Described as “computer protocols that facilitate, verify, or enforce the negotiation or performance of a contract”, smart contracts are an important product of blockchain technology and have several applications in the financial world. They are computer code that is stored and replicated on a distributed ledger platform (like blockchain), which can enact pre-determined operations if and when a circumstance occurs. They're supported (and verified) by numerous computers (just like blockchain), which is meant to ensure trustworthiness. In short, the 'contracts' are actually coding that makes a calculation under predetermined conditions and is verifiable and trustworthy in the same way as blockchain.
Smart contracts have huge potential in the field of complex financial transactions. In a blog post published on FX-MM, Nigel Farmer, of Software AG, outlines some of the potential uses and benefits of using smart contracts in complex financial processes. He writes that smart contracts can:
- streamline the counterparty agreement process;
- generate a coupon structure and have access to distributed ledger static data;
- automatically calculate floating payments;
- drastically speed up the affirmation and confirmation process;
- reduce complexity, which means fewer reconciliation issues;
- increase efficiency and reduces costs.
How could this apply to the world of the corporate treasurer?
There are several uses for smart contracts that are being developed within the financial space. Corporate treasurers should at least be aware of these before someone mentions them in the boardroom. Here are just a few examples of how smart contracts could impinge on treasury:
1. Bank account management
Smart contracts could be used to control many of the functions available as part of a bank account. Features such as: paying direct debits; cash sweeping, zero-balancing and other cash management tools; sending out alerts when the balance goes below a certain threshold; and many other actions that are carried out when certain circumstances occur (for example, a change in balance or external factors such as interest rate movements) could all be controlled with a smart contract.
2. Legal agreements
The technology can also be used to create new types of commercial legal agreements, adding a new way to articulate and enforce terms or to include specific incentives into contracts. This could enable machine-to-machine commerce in future – one example might be a washing machine ordering and paying for its own detergent. Josh Stark, a lawyer at Ledger Lab, writes: “Smart alternative contracts might enable an entirely new type of commerce carried out between our computers, cars, phones, and appliances.”
3. Trade clearing & settlement
Deloitte writes “The opportunity to streamline clearing and settlement processes with the blockchain and smart contracts is immense.” The R3 consortium, including 40 banks, is testing applications for smart contracts that include clearing and settlement activity.
4. Supply chain and trade finance documentation
As seen in the news of the letter of credit (LC) documentation guaranteeing a trade between Ornua and the Seychelles Trading Company (a pilot trade conducted by Barclays and tech company Wave), blockchain has huge potential to speed up trade finance by using verifiable, trustworthy, accessible digital documentation. Smart contracts also have the potential to manage the workflows needed in the trade finance process – in which documents can automatically be transferred or delivered for approval and payments can be initiated automatically when all conditions are met or signatures for the contracts are provided.
More on smart contracts
Here are seven useful sources for more background on smart contracts, plus their financial uses:
- Deloitte – Getting smart about smart contracts – CFO Insights
- BBVA – Smart contracts: the ultimate automation of trust?
- DLA Piper – The blockchain revolution, smart contracts and financial transactions
- KWM – 10 things you need to know about smart contracts
- Bitsonblocks – A gentle introduction to smart contracts
- Ledger Labs – Introduction to Smart (legal?) Contracts — Part 1
- Blockchain Technologies – The Ultimate Guide to Understanding Blockchain Smart Contracts
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