Blockchain and 'Smart Contracts': FinTech Innovations to Reduce the Costs of Trust

Abstract

Financial technology (FinTech) innovations have the potential to reduce transaction costs. More specifically, blockchain and “smart contracts” aim at decreasing monitoring and enforcement costs (i.e. the “costs of trust”). Thus, blockchain and “smart contracts” can free financial institutions from relying on post-trade financial market infrastructures (FMIs) and improve market efficiency in clearing, settlement and transactions management. However, among others, blockchain and “smart contracts” carry new risks (attributable to operational risk) that require adequate governance systems. Basing its analysis on the MiFID II rules on high-frequency trading (HFT), this article sets the grounds for a new risks governance model specifically addressing “smart contracts”. More specifically, this article stresses the necessity that financial institutions develop “internal sandboxes”, in which “smart contracts” can be fully tested and monitored before their definitive execution on blockchain platforms.

Keywords: FinTech, transaction costs, trust, third-party agents, blockchain, Distributed Ledger Technologies (DLTs), smart contracts, clearing and settlement, market efficiency, operational risk, risks governance, high frequency trading (HFT), MiFID II, internal sandboxes