“Contracts have existed in one form or another for as long as barter has existed in civilizations, going back to stone inscribed hieroglyphics in Mesopotamian era.”
In the “Merchant of Venice”, Shakespeare eloquently depicts the excesses of greed, where
The emergence of platform monopolies for peer to peer interactions, albeit centrally managed by fee gateways: We are now witnessing the emergence of a new class of platforms based on mathematically engineered trust. This is a leap from the previous decade of socially engineered trust, community-created content, and community-generated inventory, which saw the rise of platform monopolies such as Facebook, LinkedIn, Twitter, Instagram, YouTube, Airbnb, Uber etc. with a centralized platform manager managing the community for his gain and not that of the community.
The last decade was fortuitous for those social platform owners that the community embraced those innovations as a social good, when indeed they later emerged more deviant than other profit-seeking firms, because exploiting trust reposed by public in a platform on a gigantic scale and abusing it is viler than the gimmicks employed by a typical commercial firm to boost their advertising revenue. However, the remarkable success of these platforms with unprecedented market penetration such as close to half the world’s population is a resounding validation of the need for massive platforms that bring humanity together for trusted peer to peer interactions. The previous era of platforms thrived on community-based reputation and influence scores, also unduly influenced by those who were willing to spend on marketing and ad budgets, to the benefit of the centralized owners who repeated profits.
What are the implications when such socially engineered trust is replaced by trust derived from algorithms and game theory? What if mathematically guaranteed trust complimented by auditability and transparency is now possible in the new paradigm, which was once obscured by centralized platforms driven solely by profit maximization? The implications are enormous, and we are starting to witness a paradigm change with a whole new class of financial instruments that do not rely on an arbiter to dispense the deliverables. These new class of instruments
However, reality is not so utopian, and at least in the current scenario there are several problems with smart contracts; not with-standing the functional challenges such as:
• throughput & speed
• limitation on block sizes
• absence of education
• absence of universal standards.
The potential market for security tokens is estimated to be $500 trillion and investments in security tokens space have already exceeded $500 million in 2018. So it is an opportune moment for serious infrastructure players in Digitized Securities industry to pause and take stock of risks that apply to this new space and be prepared with a risk management strategy.
Smart contract risks specifically in the domain of marketplaces and securities
• Unlawfully circumvent rules and procedures
• Diminish transparency and accountability
• Impair market integrity
• Introduce risks, including operational, technical, and cyber security
• Be subject to fraud and manipulation Source CFTC Labs
So smart contracts may need a dispute resolution mechanism, ombudsman, or arbiter
Do legal frameworks apply to smart contracts?
Of course, no matter what you do, law enforcement has long arms, and bitcoin kid Ross Ulbricht of Silk Road fame, now sitting in jail is now proof.
Examples of traditional legal frameworks that apply to securities, would also apply to tokenized securities or smart securities:
• Commodity Exchange Act
• Federal & State Securities Law & Regulation
• Federal, State, Local tax laws & Regulation
• Uniform Commercial Code (UCC)
• Uniform Electronic Transaction Act (UETA)
• Electronic Signatures in Global and National Commerce Act (ESIGN Act)
• The Bank Secrecy Act
• AML Laws & Regulations
• Money Transmission Laws
Applicability of law
• A jurisdiction needs to be specified as to which law is applicable.
• A contract needs to be deemed to be signed by both parties for it to be valid However, contract law is not simply based on punishment to a breaching party.
Contract law takes into account principles of fairness and natural justice, such that it is not usurious, not unduly taking advantage of one party’s misinformed ness or adverse circumstances etc. So smart contracts need to accommodate such considerations for them to be practical, or an oversight body needs to weigh such tradeoffs. Let us now delve into details of general challenges related to smart contracts.
Best practices for programming Smart Contracts
• Prepare for failure
• Rollout carefully and in phases
• Keep contracts simple
• Stay up to date
• Be aware of blockchain properties
• Crowd-sourced escape hatches
• Security tools for catching bugs in the code
Risk Management in Smart Contracts
Innovators attempting to build new infrastructure rails in capital markets based on smart contracts need to pay heed to active risk monitoring as well as dynamic risk mitigation measures, some of which are listed below: AML, KYC
Platform Access:Platform access can be made conditional on KYC, AML, for example, MLDS, JMLSG standards. Checking whitelisted addresses to ensure asset performance
Wallet infrastructure: Wallets need to be highly secure and CCSS compliant and accessible only by whitelisted addresses
Institutional Grade Custody: Custody solutions such as being announced by Fidelity Digital Assets to store crypto assets in cold wallet storage. W
Segregation of client assets
Platform Rule Book: A rulebook can govern platform
Each transaction can be backed by a legally enforceable bilateral agreement Institutional and Operational Challenges