Using Blockchain Technology to Create Smart Contracts for Secure and Efficient Trading of Financial Instruments

The digital asset landscape is undergoing a paradigm shift, driven by the transformative potential of distributed ledger technology (DLT). At 21X, we are at the forefront of this revolution, crafting a secure and efficient trading platform built upon the bedrock of smart contracts. These self-executing agreements reside on a distributed ledger and promise to revolutionize the way we trade and settle assets, offering significant advantages over traditional contract methods.

Demystifying Smart Contracts: The Conduit for Trust
Imagine a contract that meticulously verifies and enforces its terms, automatically executing pre-defined actions upon fulfilment of specific conditions. This is the essence of a smart contract. Coded and immutably stored on a secure, distributed ledger, smart contracts eliminate the need for intermediaries, streamline processes, and minimize the risk of errors or manipulation, signalling a fundamental change for or capital markets.

As Nicolas Klose, business analyst at 21X, explains: “When it comes to trading financial instruments, smart contracts are a real game changer. Their functionality transforms how issuers of securities interact with investors, or how retail customers can manage their portfolios with significantly less reliance on third-parties. In contrast to traditional finance, peer-to-peer transactions without intermediaries become possible through smart contracts. The institutional adoption of digital assets is creating a completely new trading environment - and smart contracts are the silver bullet to enable this.”
The technical underpinnings of smart contracts involve programming languages specifically designed for DLT environments, such as Solidity, which 21X is using to underpin its market infrastructure. These languages offer features tailored for secure and verifiable execution on a distributed network. By using Solidity, 21X can provide all the advantages of smart contracts for buyers and sellers, being compatible with a wide range of public blockchains.

A Myriad of Benefits

Smart contracts offer a compelling value proposition for DLT-based trading, addressing key challenges and unlocking a number of significant benefits.

Enhanced Security

DLT's inherent immutability strengthens the security of smart contracts. Transactions and associated data are cryptographically secured, residing on a decentralized network, making them tamper-proof and resistant to fraudulent manipulation. Unlike traditional paper-based contracts, the risk of unauthorized alterations is virtually eliminated. Cryptographic hashing ensures data integrity, while digital signatures guarantee the authenticity of transactions and the identities of participating parties. To enable this enhanced security, 21X will undertake rigorous testing when it comes to our smart contracts and applications.

And Klose believes that security is a crucial factor for investors if digital assets are to gain traction swiftly. “Overall, smart contracts offer significant security and risk-mitigation benefits that can foster trust, only increasing investor comfort in the digital asset space.”

Increased Automation

Smart contracts operate autonomously based on pre-programmed logic. Upon fulfilment of pre-defined conditions (e.g., receipt of payment in a specific token and amount), the contract automatically executes the next step in the trade settlement process, such as transferring ownership of the underlying asset. This eliminates the need for manual intervention by intermediaries, streamlining workflows, accelerating settlement times (potentially from days to seconds), and minimizing operational costs.

Reduced Errors

Traditional contract execution is prone to human error, leading to delays and disputes arising from misinterpretations or manual processing mistakes. Smart contracts, however, operate with machine-like precision. By adhering to pre-programmed logic embedded in the code, they minimize the potential for errors during execution, fostering greater trust and efficiency within the trading ecosystem.

Improved Transparency and Traceability

All interactions with a smart contract are permanently inscribed on the distributed ledger. This immutable record provides a transparent and auditable history of the entire transaction lifecycle, accessible to all authorized participants. This enhanced transparency fosters trust and facilitates regulatory compliance. Regulatory bodies - as well as ourselves as part of our compliance efforts - can easily track asset movements and identify potential misconduct. Additionally, auditable trails simplify dispute resolution processes.

Programmability and Flexibility

While smart contracts are pre-programmed, they offer a degree of flexibility within their parameters. Complex logic can be encoded to accommodate diverse trade types and settlement conditions. For instance, a smart contract could be programmed to release payment only upon the delivery of a digital asset with specific attributes.

Klose adds: “This programmability allows for the creation of more complex and nuanced financial instruments that can be tailored to specific investment needs. For example, a security token could represent ownership of a share in an investment fund with a verified provenance in a licensed securities register.”

Reduced Counterparty Risk

In traditional finance, counterparty risk arises from the possibility that a trading partner may default on their obligations. Smart contracts mitigate this risk by holding both parties accountable through the self-executing nature of the agreement. Once pre-defined conditions are met – such as both parties have deposited the required assets into the smart contract - the contract automatically executes the next step, eliminating the potential for delays or non-performance. This fosters trust and reduces the need for collateral requirements.

Reduced Settlement Risk

The use of smart contracts for digital assets also significantly reduces settlement risk. As smart contracts automatically execute the terms of an agreement, there is no manual intervention, thereby reducing the risk of errors or delays. The immutability of transactions recorded on a blockchain provides a secure and auditable record of ownership and transaction history, reducing the risk of disputes. Smart contracts can also, for example, expedite the transfer of the digital asset and the corresponding payment within the same transaction, which eliminates the risk of one party failing to deliver on their obligation

Klose says: “Without question, smart contracts streamline the settlement process, making it faster, more efficient, and less prone to errors and fraud. This translates to a significant reduction in settlement risk for digital assets.”

Conclusion

21X has fully embraced the transformative potential of smart contracts, as they prioritize the customer experience in the digital asset trading arena, translating into significant competitive advantage for users.

Recognizing the transformative potential of smart contracts, 21X is committed to implementing them within its DLT platform. The company believes that by fostering collaboration, innovation, and a focus on security, smart contract-based trading will become the cornerstone of trust and efficiency for digital asset trading. By harnessing the power of smart contracts, 21X aims to spearhead a new era of efficient, secure, and transparent digital asset trading.

Klose considers that the depth and breadth of smart contract development and take-up knows no bounds. “Looking at the potential of automating creation, redemption, and corporate actions it is evident that we are just at the beginning of a smart contract-based revolution of capital markets for new and innovative financial instruments. This includes on both the buy- and sell side and will only be held back by our own imaginations.”

About the Author

Nicolas Klose is a Business Analyst at 21X, focusing on distributed ledger and blockchain technologies. He contributed to 21X’s application to become the first ESMA-regulated DLT-based trading and settlement system and is building 21X’s market infrastructure as an integral member of the Technology team.