This is part of a blog series Can Blockchain Save Our Financial System?
The blog examines how automation and transparency through Smart contracts and Blockchain could help us avoid the next financial crisis.
To read the previous blog post about How Blockchain Can Remove the Fundamental Problem in the Financial Markets, click here.
To learn about how Bloxable is building the most advanced debt platform using blockchain and smart contracts, visit us here.
Many experts believe that smart contracts can make our financial systems far more secure and reliable than traditional contracts. The automated nature of smart contracts is the key feature that helps build investor confidence and trust in the market.
Existing Industry Problems
There are major differences between smart contracts and traditional contracts on the question of who is the ultimate beneficiary. A number of unforeseen factors can affect the outcome of a contract through the legal system.
Traditional contracts can be annulled or modified by the court’s decision in a case where one party brings grievances towards the other party.
A party can also default on the contract, refusing to meet its obligations which incur losses for the affected party.
Things are different in a smart contract operating in a distribute ledger system. Smart contracts are automatically executed at each phase, as obligations are met by the contracting parties. Even if one stakeholder fails to meet its obligation, the contract stays valid for the other parties as long as they keep fulfilling their obligations.
It is very difficult to change or override smart contracts once they have been set. This is particularly important for lenders and financial service providers. Using the Blockchain smart contracts, they can be more secure in their investments and loans. The technology also allows these businesses to offer better services for their clients and borrowers.
Transparency of a Smart Contract
One major advantage of a smart contract is that it can be viewed by anyone with the authorization to do so. This allows contract holders to audit it in real-time. The smart contract maintains a complete record of all the transactions that have taken place during its history of execution.
The transparency inherently built into a smart contract allows liquidity for investors. An investor can easily offer the contract up for sale on the Blockchain to other potential investors.
Since smart contracts can be viewed by other stakeholders on the network, they allow third parties to get a better insight into the business. This lets them get a better understanding of the investors’ financial position and stability.
One of the main failings of the 2008 financial crisis was that banks and lenders could not tell the financial position of other banks. After Lehman Brothers went bankrupt, a lot of institutions were left wondering how much stake other banks had in the defaulted institution.
Banks were unwilling to advance credit to other institutions, fearing that their investment would get sunk. The resulting credit crunch made the situation worse for everyone.
Banking and financial sector is built upon trust. Once the trust is gone the whole industry can come down collapsing like a deck of cards.
An open Ledger-Blockchain would greatly enhance trust and help the markets avoid a repeat of the 2008 situation.
Blockchain Would Let the People Take Charge
One of the key features of Blockchain platform is that it removes the need for brokers and middlemen. In traditional investment banking, the brokers take charge of managing assets and funds. Critics of this system have argued that bankers cannot be trusted to make the best decision in the interest of their depositors.
Bankers will always seek to maximize their own gains. They don’t put their own money on the line. From an unbiased perspective, it makes sense to take more risk as the rewards are also greater. This was one of the key factors that led to the 2008 crisis.
Riskier securities are usually offered at a higher return. In 2008 portfolio managers made risky gambles in the market, hoping that they would make a better return before the bubble burst.
With the Blockchain, the power of investing in securities is returned into the hands of the owner of the funds. Experts believe that Investors will be far more cautious about risking their own money and this could help us avoid a repeat of 2008.
To read the next blog post in our series, about Regulators Can Use Blockchain to Avoid another Crisis, click here.
