Cryptocurrency exchange FTX’s collapse is the latest “black swan” event in the cryptocurrency industry, but it certainly won’t be the last. There is a growing need for new practices to combat these events from happening again. Tokenization is a promising option, but current tokenization platforms have significant shortcomings. They lack transparency and verifiability of cash flows, and tokenized assets require human intervention, leading to discrepancies and errors. The solution is to standardize financial contracts and implement “smart financial contracts” that define the logic of the financial instrument in a token, which can be read and executed automatically and without error.
To achieve this, liabilities and cash flows related to financial assets need to be defined with machine-readable, machine-executable, and standardized data models and algorithms. This can be accomplished by implementing open banking standards and introducing smart financial contracts that describe the underlying obligations of the counterparties.
Fortunately, the Algorithmic Contract Types Universal Standards (ACTUS) Research Foundation, a U.S.-based non-profit organization, has already developed standards that can address these concerns. ACTUS is an open-source standard that any business can use to clarify the cash-flow patterns of financial instruments based on collateralization. These algorithms focus on the cash-flow obligations of a given contract, not specific legal jurisdictions or terminology.
Combining ACTUS with blockchain results in smart financial contracts. These contracts as part of tokenized financial instruments and digital transaction rails would enable a much more efficient system for all parties – one that provides transparency and auditability. The on-chain transparency of such a system would make it impossible for financial firms to hide massive shortcomings in liquidity, making it a critical step toward reducing systemic risk.
Furthermore, tokenized financial assets will enable liquidity and new forms of financing for small and medium-sized companies, especially where established financial players have been unable to meet the financing needs due to their high-cost structures.
In conclusion, implementing standardized smart financial contracts based on ACTUS standards is critical to prevent future black swan events in the cryptocurrency industry. It is not only beneficial for trade finance and financial enterprises, but it can also be a key element to inject liquidity into local economies. It is time for financial institutions to adopt these standards and smart financial contracts to provide real-time risk modeling and stay in line with regulations.
