A subsidiary of global banking giant Intesa Sanpaolo is taking steps to reimagine what the $1.2 quadrillion derivatives market might one day look like on a public blockchain.
In a new white paper released today, Banca IMI details how an ethereum smart contract built by Intesa Innovation, Banca IMI and blockchain startup Oraclize makes it impossible for any counterparty to default by anticipating eventualities that might otherwise result from a legal dispute.
Written by the bank’s head of interest rate and credit models, Massimo Morini, the paper represents a continuation of work he’s been conducting at Banca IMI for two years. However, it also hints at what sets the bank apart in its approach to the blockchain sector.
In the paper, Morini opens with a detailed mathematical description of how collateralized derivatives meant to help offset risks can backfire.
While derivatives built on underlying assets such as cash, gold and bonds are constructed to minimize loss in more high-risk endeavors, what the report calls “a generic paper contract” might not specify data sources or algorithms implemented by the counterparties.
As a result of these uncertainties and others, discrepancies between the parties can result in default, delays and costly legal litigation. According to Morini, though, a smart contract executed on the ethereum blockchain could make this a problem of the past.
In the proof-of-concept (POC) detailed in the paper, a smart contract was built using an ethereum testnet that communicated contract details to an external computation engine located in the cloud.
Instead of risking delays and relying on courts to resolve possible disputes, Morini said the team’s derivatives workflow builds the terms of resolution into the smart contract itself.
By anticipating problems and encoding solutions, he said his smart contract-based derivative could reduce delays from days to minutes and dramatically cut the cost of resolution.
He wrote in conclusion:
These results are made particularly relevant by two facts. First, the value of cryptocurrencies and tokens has grown from 10 to more than 200 bn dollar in little more than 1 year. Investors are attracted by the opportunities of this market, yet they lack instruments to hedge and manage the risks they are taking. We have the opportunity to offer them these instruments by creating the infrastructure of a real financial market on the blockchain itself, using blockchain technology. Last but not least, the old derivatives market is worth 15 trillion. Any technology that can make it less risky has a great relevance for the future of the global economy.