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by Giulio Prisco, Sep 21, 2017

Smart Contracts and the Future of Banking


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One of distributed ledger technology’s most promising attributes, the power to enable smart contracts, has applications that reach far and wide. As blockchain technology becomes more widely adopted, many of these applications are coming to fruition.

A 2016 Forbes story titled “Smart Contracts May Create Significant Innovative Disruption” noted that smart contracts could soon extend far beyond the movement of digital cash and be used “to effectuate business activities involving purchases and exchanges of virtually any tangible or intangible goods, services and rights (e.g., sales of securities, commodities, personal property, real estate, digital rights, etc.).”

There is, however, one important roadblock to the widespread adoption of smart contracts for tangible goods, as well as non-blockchain-based intangible goods: smart contracts are confined within their native blockchain network, and unable to operate in the rest of the world.

“Smart contracts are simply software and as such they can ‘enforce’ or, better, administer the state of the data to which they have access on the blockchain,” noted a 2015 BBVA research report. “Yet, beyond that, they have little reach. For the foreseeable future, they will not be enforceable in any court and few parties will be able to rely on smart contracts alone to structure all of the terms of a commercial transaction.”

Tangibility is not a main issue in itself. In fact, one of the first conceptual examples of smart contracts, proposed by legendary cryptographer Nick Szabo in 1997, used a very tangible item: a car. Szabo spoke of smart contracts that solved the problem of trust by being self-executing and having property embedded with information about who owns it. For example, the key to a car might operate only if the car has been paid for according to the terms of a contract. Now there are companies implementing Szabo's vision, with smart locks driven by smart contracts, for example.

If the car has been paid for in cryptocurrency through the same blockchain where the smart contract lives (or a pegged blockchain), the loop is closed and everything is crystal clear. But what if the car has been paid for with a credit card or a bank transfer? Sure, the owner of the car can signal to the blockchain that the payment has been received, but then we fall back into the problem of trust: What if the owner just takes the money and runs? A better option is using an oracle to fetch the information that the payment has been received automatically from the bank or credit card company, but that requires the cooperation of the external operator.

Conversely, a smart contract on a blockchain is unable to trigger a wire transfer from one traditional bank account to another. Therefore, smart contracts are of limited utility in the real world of business, where most financial transactions take place in “real” fiat currency through legacy payment infrastructures.

So, the main issue for the widespread adoption of smart contracts is the availability of smart interfaces between the blockchain networks in which the smart contracts run and the rest of the world. This includes the banks, of course, but also the tax and compliance monitoring offices.

It seems likely that major banks could, in a few years, adopt smart contract technology themselves. It’s worth noting that virtually all major banks have blockchain pilot projects.

A 2016 Capgemini report titled “Smart Contracts in Financial Services: Getting from Hype to Reality” noted that innovative banks have started experimenting with smart contracts and “several of them are optimistic about the evolution and mainstream adoption of smart contracts within the next few years.”

Earlier this year, FinTech Network and Zerado issued a white paper on smart contracts for banks. While acknowledging the challenges that must “be overcome to allow for traditional legal contracts to be coded into smart contracts,” the white paper concludes that “[blockhain-based] smart contracts can offer many benefits for a wide range of applications for banks. If properly implemented banks can benefit from reduced risk, real-time accurate and verified transactions, fewer intermediaries and lower costs.”

Once banks adopt smart contract technology and develop interoperability infrastructure, a blockchain-based smart contract could trigger a payment in fiat currency from a pegged bank account, with all necessary exchanges and transfers taking place automatically once the conditions for the execution of the smart contract are met and all needed reporting to tax and compliance authorities done on the fly.

In the meantime, however, it seems more likely that smart contract applications for banking will be first developed by a new wave of “blockchain banking” startups that could “[zero] in on delivering entirely new financial products,” as argued in an insightful article titled “What Is the Future of Digital Banking?,” recently published by The Next Web.

One of these startups, Bankera, wants to support both fiat currencies and cryptocurrencies and provide services like any traditional bank, including payment processing and debit cards.

“[Although] Bankera acts like a traditional bank, it is crypto first by nature, pioneering innovative services like taking crypto assets as collaterals for loans,” noted The Next Web. The Bankera website states that all services will support both traditional fiat currencies and cryptocurrencies such as bitcoin, ether and ERC20-compliant tokens.

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