The Commodity Futures Trading Commission’s LabCFTC has released, “A CFTC Primer on Smart Contracts”. The primer is part of LabCFTC’s effort to engage with innovators and market participants on a range of fintech topics, and follows on from a 2017 primer on virtual currencies.
“Smart contracts are being used to drive further automation in our markets and may have an impact across a range of economic activities,” says LabCFTC director Daniel Gorfine. “This primer is focused on explaining smart contracts, exploring how they may impact our markets and highlighting potentially novel risks and challenges.”
The primer sets out to define “smart contracts”, including by exploring their history, characteristics, and potential applications that may eventually impact daily life. The primer explains early self-executing software logic evolving into current smart contract technology – for example, starting with a simple vending machine illustration and then discussing more complex examples, including credit default swap contracts.
The primer works through a range of operational, technical, cybersecurity, fraud and manipulation, and governance risks and challenges. The primer goes on to speak to the CFTC’s role to protect market users and their funds, consumers, and the public.
The primer looks at some of the potential use cases for smart contracts in financial market operations. Among these are derivatives, whereby LabCFTC says smart contracts could potentially streamline post-trade processes, real time valuations and margin calls. It also notes that in the realm of trade clearing and settlement, smart contracts could improve efficiency and speed of settlement with less misunderstandings of terms. Additionally, smart contracts could provide greater standardisation and accuracy of data reporting and recordkeeping (e.g., swaps data reporting, regulator nodes for real time risk analysis); as well as automated retention and destruction.
The primer also sets out the potential for such contracts to streamline trading of products subject to oversight by the CFTC (e.g., options, futures, and swaps) and enhance efficiency from pre-trade through post-trade (e.g., price discovery, execution, clearing, and settlement). Among the potential benefits noted are a reduction of duplicative confirmation; a reduction of trade, capital, and margin risks; automated fulfillment of contracts; enhanced compliance with internal written policies and procedures and with legal obligations and regulatory requirements; as well as Improved regulatory reporting.