Smart contracts to slash time and costs, say technologists

Blockchain to deliver lucrative benefits to derivatives market, London conference hears

Blockchain technology would underpin smart contracts for derivatives

Smart financial contracts built using blockchain technology could save banks billions of pounds by streamlining processes and obviating back-office legal work, said bank technology experts at the London Fintech Week conference on July 20.

In recent years, firms have become increasingly excited about the potential applications of blockchain – the technology that underpins digital currency bitcoin – in financial markets. One of those is the use of ‘smart contracts’, which could hugely simplify the processing and settlement of derivatives trades.

Using blockchain technology, the time taken for a derivatives contract to be agreed between counterparties could be slashed from 90 hours to three minutes, said Simon Taylor, director of blockchain at consultancy 11:FS and former vice-president of blockchain research and development at Barclays.

“Just the negotiation [of an interest rate swap] can take months, but once you’ve completed the negotiation ... just to get it agreed and settled with all those different people [takes] 90 hours,” said Taylor. “Because you’re dealing in paper, you’re dealing in people and processes. That 90 hours costs an awful lot of money – hundreds of billions of pounds.”

The figure of three minutes was based on a test case undertaken by Barclays using a standard interest rate swap, he explained. “With the blockchain we got it down to three minutes. That’s because we were driving the workflows inside of all of those organisations.”

Contract agreements in the derivatives market tend to get dragged out because of errors, delays in updating internal processes, and by firms simply being unaware of what stages their counterparties are at, said Taylor. But with blockchain-based smart contracts, many of those processes would be streamlined and automated, potentially saving the industry billions of pounds.

Blockchain uses a distributed peer-to-peer database of transactions which is cryptographically protected and verified. The distributed database means secure transactions can happen between two parties without the need for a centralised third party, leading some to suggest that smart contracts might one day replace central counterparties.

Lee Braine, a member of Barclays’ chief technology office who works on the bank’s smart contract effort, also spoke at the event. In addition to the tests already carried out with interest rate swaps, he said the bank was working towards using the technology in further tests with equity swaps and swaptions.

He was optimistic that the wider industry would soon begin feeling the benefit of smart contracts.

“Quite soon I think we’ll be able to take existing standardised documents, add additional information and simplify the workflow,” he said. “In terms of how many years it’ll then take to ripple down, right the way through to central counterparties et cetera, we’d be looking maybe at a three to 10 year period for that, but definitely within one to two years for it to have an impact in document automation.”

Other speakers predicted banks could make further savings on legal costs, with smart contracts making dispute resolution more straightforward.

Ajit Tripathi, director of fintech and digital for financial services at consultancy PwC, said the transparency and verifiability of blockchain technology would make a lot of expensive back-office legal processes obsolete.

“To some extent a lot of back office can be taken out from the assurance of performance of contracts by using blockchain,” he said. “Does blockchain technology per se reduce the cost of enforcing some of these contracts? Absolutely.”

His comments were echoed by Barclays’ Braine, who said the bank was working on tying together the legal contract and the smart code with the trade at the point of execution.

“It assists, in my opinion, in dispute resolution – and potentially, the courts – to be able to tie these things together,” he said.

The use of blockchain technology means two parties can run the same contract code at different locations simultaneously and be immediately updated on the progress of the other parties. By contrast, traditional contracts must be updated manually by legal teams.