Smart contract pioneer, OpenLaw, and oracle platform Rhombus, have joined forces to build derivatives smart contracts, as part of a project to see if their tech can be used in the $500 trillion market for handling derivatives trades.
The short version is this: Rhombus helps with the collection and transmission of real time, real world data that will relate to clauses built into a OpenLaw smart contract. Both are ConsenSys-backed companies.
The companies said: ‘[With this approach there is] the possibility to open up and provide a more transparent and accessible financial system – one that is cheaper, faster, and more efficient.
‘Once these tools are created, operational aspects of the financial world will be streamlined, reducing the role of lawyers, existing data providers, and potentially even financial institutions.’
There has already been a lot of interest in this area, as organisations such as the International Swaps and Derivatives Association (ISDA) and others, quickly saw how a self-executing contract was in some ways ideal for the fast-moving world of derivatives contracts. Law firms such as Linklaters have also been looking into this area too, at least at a theoretical level.
Now, OpenLaw and Rhombus have built call option smart contracts, a key part of the derivatives system. A call option contract gives the buyer the right to purchase an asset at a specific price , or strike price , over a specified period of time. These options can be traded over the counter (OTC) or through central clearing houses, they explain.
‘We’ve seen other attempts at executing options on a blockchain, but they fall short. The blockchain-based demonstrations move around assets, without using secure, real time oracles and are often untethered from a real world agreement necessary to manage and account for unforeseen risks or misunderstandings,’ they say.
They add that they believe they have now solved these issues and have ‘automated a standard call option contract and integrated it with a custom Rhombus oracle based on the current price of ETH to Gold’.
The following is an extract of how they did it, kindly provided by Aaron Wright, co-founder of OpenLaw:
‘We mocked up a standard option contract using our domain specific markup language to enable anyone to automate the creation of the agreement in minutes. And, we worked with Rhombus to supply the current price of ETH to Gold.
Once Rhombus deployed its oracle contract, we wrote a smart contract that read this data and cryptographically tied it to the underlying agreement. Through their simple oracle interface, the entire project was brought together. To purchase the ether/gold call option, a user simply needs to view the ETH to Gold price, which triggered the creation of a standard option contract on OpenLaw.
Once generated, parties can execute the option in seconds. For example, if the oracle displays a current price of 10 ETH to Troy Ounce, the customer could generate an option contract whereby the option holder has the right to purchase 1 Troy Ounce for 11 ETH, 24 hours from the present time.
Once 24 hours passes, if the ETH/Gold price is more than 11 ETH, the user has the option — but not the obligation — to complete their purchase. If the user decides to exercise their option, 11 ETH is transacted and the user automatically receives a token representing one ounce of gold held in a vault.
In addition to having a smart contract token represent a Troy Ounce and automatically effectuate an exchange of assets, an OpenLaw user has the security of a traditional legal agreement that is enforceable in court. The OpenLaw legal agreement for a call option defines where and how the token may be redeemed for one Troy Ounce — as well as containing representations and warranties the actual gold is held in a vault.
The cross-section of legal documents, smart contracts, and oracles, as seen in this example, has the possibility to open up and provide a more transparent and accessible financial system — one that is cheaper, faster, and more efficient.
Call options are just the beginning, soon a range of financial assets will be automatable with a click of a button. Once these tools are created, operational aspects of the financial world will be streamlined, reducing the role of lawyers, existing data providers, and potentially even financial institutions.’
So, there you go. Interesting stuff. Will organisations such as ISDA go for this approach? Will the traders? Time will tell. But, it does seem that we will get there eventually, in part because this is simply a more efficient means of executing a mass of complex trades.
And, as we steadily move forward then law firms that are involved in derivatives contract work – and there are quite a few such top firms, especially in London and New York, that do – who will no doubt be watching developments here very closely.
Plus, for more information, check out this 6 minute video below, that walks you through the process.