Smart Contracts, Distributed Ledgers, and the Need for an Algorithmic Financial Contract Standard

Abstract

Nick Szabo defined smart contracts as, “….a set of promises, specified in digital form, including protocols within which the parties perform on the other promises.” The essence of a smart contract is that it is self-executing and has a protocol to effect this, i.e. the mechanism for communicating with the smart contract. In addition, Szabo distilled four basic objectives of any contract that should be fulfilled by smart contracts. Two of these, verifiability and enforceability, are given more attention in this paper. Szabo, however, did not address what types of contracts would be most suited to be executed as smart contracts.

This paper describes first the unique aspects of financial contracts that make them the most promising candidates for implementation as smart contracts. Secondly, we analyze the conditions under which the use of distributed ledgers and smart financial contracts are most likely to prove successful. This analysis concludes that unless a distributed ledger is combined with an algorithmic financial contract standard and a standard protocol, the potential benefits of smart contracts will not be realized. The corollary to this conclusion is that it is essential for FinTech to adopt such a standard in order to be able to realize its promise of a paradigm shift in finance. The combination of distributed ledger technology and an open, well documented and well tested algorithmic financial contract standard is the next logical step in the development of FinTech.

Keywords: Smart Contract, Finance, Blockchain, Financial Contracts

JEL Classification: G, K