Cryptocurrencies were never taken seriously in the financial world, and now that Bitcoin has lost over 80% of its value from its peak at the end of 2017, the incentives to take cryptos seriously have evaporated. And while investment banks and large asset managers have publicly denounced cryptocurrency or politely professed a lack of understanding of the technology, there has been a quiet and growing interest in smart contracts.
This technology is not exactly blockchain technology, but it is close. Smart contracts are self-executing, which means that when the terms of the agreement are fulfilled, the transaction instantly occurs.
Let’s think of an example: buying a home. Let’s say that Seller A agrees to sell Home Y to Buyer B when $500,000 is transferred from B’s bank account to A. A cannot give over the legal ownership of the house until the money appears in B’s bank account, but B may also be wary of handing over this large amount of money to A, who could then disappear before handing over ownership. This is a lack of trust problem—the most typical financial problem there is.
The problem is currently solved with an intermediary: an escrow service, a bank, or in some parts of the world, lawyers. However it’s done, a dispassionate and trusted third party is given control of the transaction to ensure that A gets the cash and B gets the house.
This isn’t ideal for two reasons. Intermediaries, being human, can breech trust. While it’s rare for escrows to steal from their clients, it’s not impossible. But the bigger problem is the cost of using a human intermediary in both time and money. The third part creates a friction point that makes transactions slower (and thus inefficient) while also costing a lot of money (you have to pay the third party for their involvement and effort).
A smart contract theoretically fixes all of this. A smart contract could be set up to automatically transfer ownership of the property when B transfers the money to A’s bank account—and not before. Then when B hands the money over, s/he will know A will actually give up the house.
Assuming, of course, that A and B trust the technology. And this is the primary hurdle for smart contracts right now—they are not implemented because the financial industry does not know how to create this technology in a transparent and trustworthy way that does not remove the need for an intermediary.
If they can, however, smart contracts could lower transaction costs significantly. And, in a way, they already have. One can consider the automatic trade clearing of online stock and bond buying as a kind of smart contract, which is why stock transactions have massively declined in cost from the days of human traders on a trading floor.
We will likely see these kinds of computer-driven solutions put into place throughout finance, which will make transactions much cheaper and faster, but that might not make everyone happy. Third party intermediaries will be out of a job.