The Crypto Explorer podcast: Exploring smart financial contracts
Welcome to the written edition of our latest episode for The Crypto Explorer, a podcast by Sygnum, which takes you into the exciting world of crypto assets and Future Finance with conversations with leading figures in blockchain and finance.
In this episode, host Aliya Das Gupta and guests Dominic Lohberger, Head of Trading and SIS at Sygnum, and Ralf Kubli, Board Member at Casper Association, discuss how smart contracts can be used in financial infrastructure.
Listen to the full podcast episode here.
Aliya Das Gupta: What is a smart contract and why is it something special?
Ralf Kubli: Smart contracts are generally referred to what is being programmed on Ethereum, Solidity and other environments. I think the name is a bit misleading. Even Vitalik said it was a bit unfortunate that he used this term, because these smart contracts are not necessarily smart. They just do what you tell them to do.
It becomes interesting when you really look at the definition of Nick Szabo. He mentions that a piece of software becomes a smart contract when it is observable, verifiable and has some privacy. As a result of these characteristics, it becomes enforceable. In finance this has big implications because the notion of observability and verifiability brings option opportunity for scaling in an environment that is still fraut with manual intervention and reconciliation.
Dominic Lohberger: I think in many ways, smart contracts form the foundation of what we call the DeFi industry today. DeFi (decentralised finance) is built upon the assumption that you can execute a slightly more complexed transaction than a simple transfer on the blockchain.
Smart contracts form the foundation for many of the use cases we see within DeFi such as lending pools, decentralised option vaults (a financial contract represented on the blockchain), or cash flows tokenized on the blockchain. Many of these use cases are not particularly new to the financial world, but the decentralised finance space managed to move them onto the blockchain layer.
Aliya Das Gupta: From the premise of the smart contract being verifiable and observable, is it too simplistic to say that it is essentially a regular computer programme? Just the fact that everyone can see it and cannot change it means that it changes the dynamic of its execution. Would this be correct to say?
Ralf Kubli: In finance, it is about cash flows and their verifiability. We need to have a clear picture of what these cash flows are in the future. Ideally, the understanding derives from the machine readable and the machine executable.
For DeFi and decentralised environments to expand, they must be able to consider cash flows over time. For example, in a debt environment, term loan or a credit environment you need to understand the cash flows over time.
Aliya Das Gupta: What do you mean by the cash flows in a debt environment?
Ralf Kubli: If you go to a bank or lender for credit, they give you an amount of money today and you sign an agreement that within certain amount of time you must pay this amount back, and in between you pay interest. This cash flow accumulates over time.
Dominic Lohberger: In terms of cash flow, the way I look at it, is that you have three layers of complexity. As a first layer, there are cash flows set at the beginning of the contract that do not change over time, such as interest payments. As a second layer, there are event-driven cash flows. A great example of this is an option contract, where if a certain price is reached, you have a certain cash flow. Finally, on a third layer, there are more complex transactions that rely on data sources to sort the decision on what, whether and when the cash flow is required.
Aliya Das Gupta: If we are looking at these three types of complexity of cash flows added into the new kind of format of open finance, all of the data is available and observable. What sort of opportunities do you think this gives rise to?
Ralf Kubli: At Casper we thought about how to bring it in. Currently, we are integrating an open-source standard for the description of these cash flows that Dominic mentioned. This open-source standard is called ACTUS, which stands for Algorithmic Contract Type Unified Standard. We use this standard because it enables some of these obligations to become machine auditable. Suddenly, we have the observability that is introduced with the blockchain and verifiability. When you understand the nature of the cash flow in an algorithmic way, when it is defined mathematically, it is clearly codified in the tokens or in the smart financial contract. So, if what happens and when the cash flows occur are defined, then we can also start to machine verify those instruments without any reconciliation problems.
Listen to the full episode here to learn what Ralph Kubli means when he talks about smart contracts.
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