Smart Contracts: The new financial institution?

The rise of blockchain-based technology has created a new standard of currency that is at its core decentralised, democratic and ‘trustless’. From Satoshi Nakomoto’s foundational paper, “Bitcoin: A Peer-to-Peer Electronic Cash System” (2008), and Bitcoin’s launch in January of 2009, cryptocurrency has grown from a novel payment method to a universal alternative currency with over two hundred million people owning wallets and utilising digital assets.?

In fact, the amount of unique owners has doubled this year: last month Crypto.com reported that owners of cryptocurrency grew from 106m in February to 221m in July. The current cryptocurrency market cap stands at USD $1.96 Trillion, up 254% YTD and up 753% over the last two years. A true triumph for the crypto community as adoption is becoming mainstream.?

But what drives ownership of cryptocurrency? I researched this ad nauseam, citing the PYMNTS x Bitpay May 2021 report and a variety of other industry reports surveying groups of consumers on their use and knowledge of crypto. The most common reason why people own cryptocurrency was for investment purposes, and the most common reason why people chose not to own cryptocurrency was the perception of extreme volatility and/or lack of knowledge.

This dualistic nature of adding crypto as another investment or avoiding crypto because of volatility lacks depth but despite this still dominates the public discussion on the topic. This limited scope has pigeonholed the entire industry and left millions of consumers in the dark about the revolutionary technological advancement that are being achieved within the blockchain community.

A poll of owners and non-owners knowledge on niche Decentralised Finance (DeFi) protocols, such as Aave, Uniswap, Convex Finance, Curve, DAO, 0x and Synthetix would be all the data to show that even owners are completely unaware of the possibilities beyond an ‘investment’ or a ‘volatile’ asset. At the centre of these protocols lies smart contracts.

Smart contracts resolve contractual conditions without large inefficient intermediaries. Real-world applications span from loans, insurance premiums or ‘handshake deals. The term was coined by renowned cryptographer and computer scientist Nick Szabo.?

Szabo’s paper “Smart Contracts” (1994) proposed a digital alternative to paper, removing the need for intermediaries by compiling complex structures and functions into a single contract that could be trustless and fair based on agreed terms. Szabo cited a vending machine as the oldest smart contract, taking in cash, querying that payment has been received and returning the selected product.?

Szabo built upon this concept in his influential paper “Formalizing and Securing Relationships on Public Networks” (1997) and “Secure Property Titles with Owner Authority” (1998), both expand on the use cases of smart contracts and how they would revolutionise everything from E-Commerce to legally binding documents.?

Three years later, Ian Grigg and Gary Howland’s “The Ricardian Contract” (1997/2004) was instrumental in outlining the architecture of a smart contract. Less than two decades later, Viatlik Buterin implemented smart contracts into the Ethereum main net.?

Today users can receive loans within minutes on Aave, provide liquidity on Uniswap as an Automatic Market Makers (AMM) and trade from peer-to-peer on 0x, all possible through smart contracts.

Specifically, Aave, originally known as Ethlend, has grown from a lesser-known protocol to having over USD $23B of digital assets locked in smart contracts. Unlike modern financial institutions, users depositing or borrowing on Aave retain custodianship of their assets. The smart contract essentially acts as the financial institution whilst returning what would be the bank’s profit margin back to the user.??

Australia's flagship savings product offers a simple 0.05% p.a on deposited funds. But if you were to deposit a stablecoin, such as DAI or USDC to the Aave protocol you would earn 2.89% p.a and 1.33% p.a in Aave’s governance token. These tokens can be used further in liquidity mining, staking or peer-to-peer swapping, potentially doubling returns whilst also never losing custodianship of your digital asset.

Additionally, if your bank were to go bust, the Australian government would cover up to AUD $250,000. If Aave were to go bust, no tokens would be lost in the process because you have retained custody.

Of course, this isn’t without risks, which there are many particularly for the uninitiated. It is easy to cite DYOR when discussing the risks of DeFi, but to keep this article in focus, I’ll also provide another article in the future outlining the various risks from flash loan attacks to smart contract exploits.?

The beauty of protocols similar to Aave is that they make lending currency efficient. If you have ever applied for a loan or worked in the lending space ask yourself “how many people have viewed this application?”. How many people from the customer’s initial interest to finally receiving credit? How many brokers, risk assessors, underwriters, managers, and administrative staff have been required to glance at the document.?

And yet, the loan can be denied because Bob from the admin team didn't put a page number on what was meant to be page 22, effectively killing the application and stymying the process.

Aave and similar protocols return financial liberty back to the consumer and maintain a high level of transparency. Their source code is on Github.

Smart contracts have come far in the last two decades, from ideation through to deployment. The future will look back to this year and know that this was only just the beginning.?