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Designing Trust – Weighing The Utility of Smart Contracts Against The Risk of Decentralization

By the year 2025, around 10% of the world’s gross domestic product (GDP) will be stored on blockchains, according to a report that was published by The World Economic Forum in August, 2016. Smart contracts are forms of electronic contracts that are coded and executed on a blockchain, and can disrupt global finance by omitting the need for intermediary third parties. Use cases of smart contracts in the financial sector include the following:

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  • Overseas payments to reduce transactions’ fees, capture obligations and minimize operational human errors.
  • Real estate business and insurance casualty claims to eliminate the need for third parties.
  • Syndicate loans to aid in real time loan funding and automate servicing operations without the need for intermediaries.
  • Lending and deposits in trade finance to automate the process of creation and management of various forms of credit facilities which would ultimately eliminate the need for retail banking services.
  • Capital raising via contingent convertible bonds to forewarn regulators whenever absorption of a loan needs to be activated and reduce the demand for point-in-time stress testing.
  • Compliance within the context of investment management to formulate reporting and aid in automation of periodic filings.
  • Proxy voting within the context of investment management to automate the process of end-to-end confirmation via votes’ validation and maximize transparency.
  • Re-hypothecation of assets in market provisioning to promote real-time asset history reporting and reinforce regulatory constraints via facilitation of settlement and clearance to omit the need for intermediary third parties and minimize settlement time.
  • Equity post-trade throughout market provisioning to transfer cash and equity simultaneously in real-time and reduce the possibility of occurrence of errors that can affect settlement.

The policy connotations of decentralization and the blockchain technology require economists and attorneys to understand the mechanics of this technological shift and the risks that emerge from tangible factors ( e.g. utilization of consensus as a security measure) and intangible factors ( e.g. script errors and occasional incompleteness of some smart contracts). A recently published paper examined the trust design of smart contracts, while balancing the utility of smart contracts against the risk of decentralization. Percy Venegas, the author of the paper, proposed a method for decision making that measures utility by means of “levels of trust” via utilization of artifacts from the financing sector and applying them to a portfolio that is comprised of smart contract cooperations.

Expected utility was estimated via mapping of a demand vector field, i.e. the attention level, and funding through creation of a scalar field, i.e. the investment level; the associated risk exposure is implied in the consensus mechanism tradeoffs, with regards to the progression of firms represented in the system of coordinates. This aims at creating a device for construction and analysis of a given portfolio. The data utilized in this study represents 200 million web users as well as a number of investment databases. The results of the paper represents a scalable and comprehensive view of decentralized portfolios that are inspired by the methodologies of behavioral finance.

Results of The Study:

The author of the paper concluded that utilizing a field’s approach when constructing portfolios, has revealed essential demand signals that are dependent on levels of trust. Trust flourishes with increased visibility and trust is resolved whenever funding sources are realized. Nonetheless, the nature of some of this attention can occasionally be detrimental, as is the case of negative brand associations. Digital businesses represent part of the economy of attention, and in the case of smart contracts, one should pay attention that they also operate within the context of the economy of attention as well.

The market share of digital businesses and the ability to acquire new investors/adopters quickly, and retain current users, are pivotal to promote the survival of most platforms that rely on the smart contract technology. Accordingly, enterprise users are required to collect competitive intelligence and take their due diligence to perfection before commencing in a pilot. How can one know all this, if the tangible value and associated risks are not ideally visible? It is worth mentioning that the initial step in the process of meta automation is rendering these signals tangible so that machines would efficiently manage machines, which is the main goal of the smart contract technology. Within this context, this paper can be useful to both blockchain developers and fund managers.

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