Archive for June, 2018

Smart Contracts (Part 2): Intermediaries? We don’t need no stinkin’ intermediaries!

By Richard Stobbe

In Part 1 (Can Smart Contracts Really be Smart?), we looked at smart contracts, and how “smart” they really are – if you need some background, start there.

Smart contracts (or “programmatically executed transactions”) have been touted as a possible solution to a range of business problems, as well as the death knell for intermediaries. By deploying DLT on a private shared ledger, the power of the blockchain is harnessed to leapfrog past traditional intermediaries. This enables more efficient transactions, free from the constraints and incremental expenses imposed by banks, auditors, governments, regulators, lawyers, accountants and others who take a pound of flesh from the transaction workflow.

By shuffling off the intermediaries, the smart contract is free to move efficiently in the economy, saving time and money for participants. To adapt a phrase from the Humphrey Bogart vehicle The Treasure of Sierra Madre: Intermediaries? We don’t need no stinkin’ intermediaries! At least… that’s the current hope for blockchain-powered smart contracts.

Are there any concerns with this vision?  One of the current constraints in the smart contract ecosystem is the gap between tokenized indicators of value on the ledger, and the almighty dollar. Or the euro. The pound sterling. The yen. The yuan. Or whatever fiat currency you may wish to use to transact business in the real world. As much as we’d like to envision a post-money world, the reality is like the QWERTY keyboard. Or the Microsoft operating system. It may not be the best. But it’s got massive market penetration. In the case of the QWERTY keyboard, we’ve been stuck with it since the 1800s. In the case of  money as a currency, since the 11th century.

Ten centuries of market inertia is not easy to shift.

That gap – between the digital representations of value, and real world money – must be efficiently closed for smart contracts to gain widespread traction. Maybe eventually we’ll move past “money” in the way voice-activation moves past the QWERTY keyboard. But that’s a long way off.

In the meantime, smart contracts powered by DLT will have to peg a tokenized “dollar” to a real dollar in the sense that the token is backed by the dollar: this is the concept of a fiat-collateralized digital representation of a real dollar, or a stablecoin.  “You deposit dollars into a bank account and issue stablecoins 1:1 against those dollars.” This has obvious advantages over a crypto-collateralized coin, which suffers from wildly unpredictable price fluctuations. A stablecoin is simple and resistant to price-volatility. However, “It requires centralization in that you have to trust the custodian, so the custodian must be trustworthy. You’ll also want auditors to periodically audit the custodian, which can be expensive.”

But wait, we already have a trusted centralized custodian of collateralized digital representations of value: It’s called a bank!

As noted in Blockchain and Shared Ledgers: “You could say that the technology service provider is replacing the traditional third party intermediary on a private shared ledger – in the way that they are maintaining and operating the shared ledger technology systems …” (My emphasis).

To put this another way, does this mean software companies are the new banks? The concern here is that users of private shared ledgers will not shuffle off intermediaries; rather they’ll swap one intermediary for another.

I’m just as happy as the next guy to grumble about banks, but they will likely be with us for a while, complete with the government regulatory environment, the industry watchdogs, the legacy payment rails, and centuries of inertia. I’m not saying the banks can’t be disrupted. But the disruptors will also take their pound of flesh.

Ok, maybe we do need intermediaries after all. Users of private shared ledger systems must be aware of the attendant costs of switching to new intermediaries, and the legacy costs of continued dependence on old intermediaries.  Where smart contracts on private shared ledger platforms can efficiently bridge the gap with traditional payment ecosystems , there will be some fruitful opportunities.

 

Looking for legal advice on smart contracts, DLT and private ledger consortium? Contact the Field Law Emerging Technology Group.

Calgary – 07:00 MT

 

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