Leveraging Smart Contracts and Currency Programmability for more Optimised Settlement

I am convinced that smart contracts are the future for settling financial transactions.

What are smart contracts? Smart contracts encode the terms and conditions of transactions, executing them automatically when specific triggers are met. It's like having a trustworthy digital assistant handling your deals in real-time.

Currently, the majority of back and middle office tasks required to complete a settlement are done manually, a practice that has persisted for decades. While there have been some minor upgrades and developments over time, there hasn't been a significant change in this process.

For me, smart contracts are the change we need. They are more than just lines of code; they are reliable, trustless teammates that will streamline your business operations. They will enable automated interactions between two distinct counterparts, eliminating the need to depend on a partner's responsiveness or internal processes. With smart contracts, manual tasks like verification and reconciliation will become a thing of the past. They will boost security, transparency, and efficiency, making business transactions smoother and more reliable.

Today, most basic FX transactions use a mechanism called DvP (delivery versus payment). This settlement method guarantees that a payment in currency A only occurs when the payment in currency B is received. DvP eliminates FX settlement risk for the biggest financial institution because they will not send any funds before receiving the counterpart’s funds. New mechanisms called PvP (payment versus payment) help to mitigate risk, however they are not available for many trading pairs, they rely on third parties and they are unsuitable and deemed too costly by market participants, so that risks remain. I believe that smart contracts are the answer to this outdated process.

Smart contracts will optimise FX transaction settlements. In fact, we already do it for cryptocurrency trades via atomic swaps.

Atomic swaps are automated, self-enforcing cryptocurrency exchange contracts that allow cryptocurrencies to be traded peer-to-peer without the need for a trusted third party. Using HTCL smart contracts, atomic swaps enable trades to occur in a fully trustless manner without counterparty risk. This method of payment offers a way for digital currency payments to operate over non-traditional mechanisms like the DvP mentioned above.

The image above demonstrates the mechanics of an atomic swap. Upon Party A's transfer of digital currency 1, the smart contract securely holds the assets with a hash (like a lock) until Party B submits their digital currency 2. Once both currencies are confirmed, the smart contract autonomously releases the assets. This synchronous exchange ensures both parties receive their preferred currencies simultaneously, fulfilling the terms of the smart contract and enabling comprehensive contract verification.

Now how do we make this a reality for FX transactions?

For this to occur, we need fiat currencies to become programmable.

For me the real question is not whether it will happen, but when? Will it happen through the use of CBDC? Stablecoins?

Either Way businesses must adopt a forward-thinking approach towards utilising cryptocurrencies, recognising their advantages in terms of cost-effectiveness, transparency, speed, and global accessibility. Leveraging cryptocurrencies and conducting transactions via smart contracts is the optimal strategy to capitalise on these benefits.

At Fipto we are confident that blockchain based transactions are the way forward. They act as a means to facilitate seamless borderless transactions and optimise treasury management processes.

If you're looking to learn more on this topic, reach out to us through our website or schedule a demo with us.

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