A Blockchain Grand Challenge: Smart Financial Derivatives

Abstract

Blockchain and distributed ledger technology (DLT) research encompasses use cases ranging from social innovation to banking, and technical developments ranging from cryptography to semantics of legal text. Research in both academia and industry is highly interdisciplinary across domains such as computer science, linguistics, law, cryptography, banking, economics and social sciences. The growing complexity of blockchain science and use cases, coupled with the interdisciplinary nature of the research, poses new challenges to our community.Research publication plays a key role in supporting this highly interdisciplinary work: supporting the need for rapid and reliable dissemination of preliminary and final results, and the need for longevity of results beyond the end of financial or management support for a research project. Industry teams rarely have subscriptions to academic journals, and an open access journal adds substantial value in supporting the research community.The field is young, with many research challenges to be addressed. One “grand challenge” for our research community is the implementation of high-value, long-lived, financial derivatives transactions running as smart contracts on DLT (“smart financial derivatives”). This is currently being explored by academia, banking practitioners, trade associations and technology vendors, and is driving research across a wide range of research groups, each focusing on a different aspect. All of these aspects must be solved, and their solutions combined effectively, to provide efficient and resilient solutions to the grand challenge. The following outlines a few of the major research questions being investigated:SEMANTICS AND VALIDATIONDerivatives trades are defined by their underlying legal agreements, and the behaviour of smart contract code must be verified and validated against the legal rights and obligations (Magazzeni, McBurney and Nash 2017, Al Khalil et al 2017, Clack 2018). Can formal methods be deployed to obtain and match the semantic descriptions of contract and code? Is it possible to “codify prose” (Hazard and Haapio, 2017), or to reimagine legal drafting to become more programmatic, with more straightforward semantics (Legalese 2017)? WORKFLOWEach derivatives agreement is separately negotiated, and testing validation and certification of smart contract code will be time consuming. Can a methodology of code templates be established to match the established workflow of legal agreement templates and to streamline the verification and validation process (Clack, Bakshi and Braine, 2016)?PARTIAL AUTONOMYSmart derivatives must not be entirely autonomous – they can run for many decades and changes in law might make their actions illegal. Code must be stoppable and modifiable, and at times human discretion must also be applied. How could “ask a human” states be best coded, and what issues arise? (Marino and Juels, 2016)INTER-CHAIN TRANSACTIONSThere might initially be a separate DLT/blockchain for each country to support domestic transactions. To support cross-border transactions, how could members of one such chain link across to trade with a member of a different chain? How would inter-chain communication and interoperability work and what issues arise (Hsu 2017, Interledger 2018)?PLATFORM AND LONGEVITYSmart contract code is created using different programming languages for different DLT platforms. This variety is likely to continue with many new developments – how can banks be insulated from variety and flux? Perhaps a common language for smart contract code on any platform? And what issues arise in deploying a platform that is guaranteed to function reliably for smart derivatives contracts that run for several decades? (Hanada et al, 2018)LEGACY INTEGRATIONSmart financial derivatives will be deployed incrementally, and DLT platforms must integrate with institutional legacy infrastructure. What issues arise in achieving this integration? Might the short-comings of the legacy systems stifle the benefits of the DLT platform?PAYMENTSWhat issues arise with an effective DLT payments system that preserves privacy, provides settlement finality similar to central bank money, is fast and scalable, and integrates with legacy infrastructure (Mills et al, 2016)? Avoidance of double-spending is crucial to trust – what is the most effective and least expensive way to achieve this aim?PRIVACYWhat are the drivers of privacy requirements and how viable are privacy guarantees, whether based in cryptography, information theory or other science (De Filippi, 2016, Halpin and Piekarska, 2017)? What are the tradeoffs between ensuring data privacy and increasing integrity and resilience?COMMON DATA AND PROCESSESTo accrue the greatest benefit to banking, data and processes must be standardized across products in an extensible way (International Swaps and Derivatives Association, 2017). Would a virtual machine (VM) for derivatives processing facilitate a “plug and play” environment for DLT technology below the VM and business processes above the VM?CONCLUSIONProgress will depend critically on interaction and communication between research groups. Frontiers in Blockchain aspires to be the premier medium for blockchain and distributed ledger open-access publication and to foster a collaborative and open research spirit within which to address this and other grand challenges.