EFFECT OF SMART CONTRACT ON FINANCIAL MARKETS

EFFECT OF SMART CONTRACT ON FINANCIAL MARKETS

Background Of The Study

The emergence of advanced technologies has led to increased competition between business as each tries to utilize the latter to bolster the employees' productivity and the general performance of the firm (Chen, and Chiang, 2012). As a result, technology has become a critical backbone of organizational operations and a core driver of organizations’ innovations and competitiveness. According to Iansiti, and Lakhani(2017), business enterprises have shifted from the traditional ways of business and have consequently adopted modern, more reliable and cost-efficient mechanism; smart contracts are some of these mechanisms.

Any financial transaction that is carried out by an organization with third parties can be viewed as a form of a contract, however simple, or complex the transaction is. Essentially, financial openness and transparency are some of the core aspects of successful organization management as they create an environment that is conducive not only for investment but also for the establishment of trust with different organization stakeholders(Chen, and Chiang, 2012). The blockchain technology is a common buzzword today, perhaps due to the unique technology that it is based on. A blockchain is a chain of transaction records, usually referred to as blocks, that grows autonomously, and all the records are linked together to form a chain, and secured through cryptographic techniques(Christidis, and Devetsikiotis, 2016).  A block may contain one or more records, and each block holds the hash function of the preceding block, the transaction data, and timestamp(Swan, 2015). Once the block is completed and committed, it is chronologically added to the blockchain and cannot be modified.

These characteristics of the blockchain technology make it highly useful as it is secure, reliable, and the ability to monitor the digital transaction is warranted(Kosba, 2016). The blockchain technology has vastly been used in cryptocurrencies such as Bitcoin and Etherium. Cryptocurrency can be viewed as a virtual or digital currency that entails the use of cryptography to promote the security of the financial transaction. As such, a cryptocurrency can be used as a secure medium of exchange as it utilizes high cryptography to ensure verifiability of asset transfer, control of unit creation and evades regulations that may otherwise be imposed by bodies such as government institutions(Iansiti, and Lakhani. 2017). 

A smart contract can be defined as a self-executing contract that utilizes blockchain technology to digitally enforce, verify, or facilitate the performance or negotiation of a contract(Christidis, K., and Devetsikiotis, 2016). Owing to the security and decentralized system exhibited by blockchain technology, smart contracts can foster transaction credibility between contracting parties without the necessity of third parties as exhibited in normal contracts. Organization performance is greatly determined by the strategies employed by the management in streamlining organizational processes, operations, and bolstering the employees’ productivity. Being a new technology, smart contracts through blockchain technologies bear the ability to positively or negatively impact the performance of a firm; hence, such a study is critical. Any business organization that aims at achieving greater heights in management and production dimensions must consider utilizing robust technologies that are aimed at bolstering its competitive edge. Owing to the newness of smart contracts, characterized by very few studies on the same, this research at out setting the effect of smart contract on financial markets.

1.2 Statement Of The Problem

Due to the high information asymmetries found in financial markets, there have traditionally been a great number of regulations aimed at lowering the risk for both borrowers and lenders. However, there still exist certain costs and dangers to using financial markets. Economic literature assumes that such transaction costs are the result of an unpredictable and complex world, where humans do not have the capacity to design contracts that plan for all possible contingencies. Among other problems, this can lead to hold-up situations where uncertain and relationship-specific investments create unequal bargaining power between seller and buyer or capital provider and capital receiver. Here, even though both parties would benefit from transacting, they refrain from doing so because of their lack of trust in one another. While the most prominent solutions of problems related to transaction costs are based on either vertical integration (Williamson 1979, Klein et. al. 1978) or a clear definition of property rights (Grossman and Hart, 1986), the emergence of blockchain technology has created a third possible option for overcoming or at least reducing transaction costs.

An inherent characteristic of the blockchain technology is its ability to trigger transactions automatically. This feature has greatly increased the possibility of computer programs that are capable of facilitating, executing, and enforcing the performance of an agreement. While the idea of such smart contracts dates back to the late 1990s (Szabo 1997), gradual implementation has only recently begun. The potential impact smart contracts can have on our increasingly digital economy is of immense significance and should not be underestimated. The ability to enforce contracts at virtually no cost drastically reduces the need for supervision while allowing an increasing number of businesses and people to trade more frequently and more efficiently. By eliminating various types of intermediaries smart contracts will likely disrupt numerous sectors of the financial industry as well as our economy as a whole. The possible scope of this change has already been addressed in the literature and is often listed as a potential fifth "Disruptive Computing Paradigm" - after the mainframe (1970s), the PC (1980s), the Internet (1990s) and social- and mobile applications (2000s) (Swan 2015a). Whereas the Internet has revolutionized the exchange of information and data, smart contract technology can fundamentally alter the exchange of assets and valuables. While there exist a number of whitepapers and articles on the technology itself, we still lack a thorough understanding of how this change will take place and to what extent different intermediaries and sectors of the financial industry will be affected. By identifying the underlying technological and economic processes involved in smart contracts this study aims to close the aforementioned research gap and contribute to the current scientific discussion. Hence, this study seek to examine the effect of smart contract on financial markets.

1.3 Objectives Of The Study

The overall aim of this study is to critically examine the effect of smart contract on financial markets. Hence, the study will be channeled to the following specific objectives;

1. Ascertain whether smart contract reduces moral hazard and adverse selection problems by automating trading processes.
2. Ascertain whether smart contract plays a significant role in lowering information asymmetries.
3. Ascertain whether smart contract plays a significant role in enhancing market transparency.
4. Finds out whether smart contract reduces transaction costs.
5. Finds out whether smart contract enhances process efficiency.
6. Finds out whether smart contract ensures the security of information.
7. Identify the challenges of smart contract in financial market.

1.4 Research Questions

The study will be guided by the following questions;

1. Does smart contract reduce the moral hazard and adverse selection problems by automating trading processes?
2. Does smart contract play a significant role in lowering information asymmetries?
3. Doe smart contract play a significant role in enhancing market transparency?
4. Does smart contract reduces transaction costs?
5. Does smart contract enhance process efficiency?
6. Does smart contract ensure the security of information?
7. What are the challenges/limitations of smart contract in financial market.

1.5 Research Hypotheses

H0: Smart contract has no effect on financial markets.

Ha: Smart contract has an effect on financial markets.

1.6 Significance Of The Study

This study will help to deepen our understanding of smart contract, its relevance, limitations, and its effect on financial market. Additionally, subsequent researchers will use it as literature review. This means that, other students who may decide to conduct studies in this area will have the opportunity to use this study as available literature that can be subjected to critical review. Invariably, the result of the study contributes immensely to the body of academic knowledge with regards to the effect of Smart contract on financial markets.

1.7 Scope Of The Study

This study is structured to generally examine the effect of smart contract on financial markets. However, the study will border down the relevance of smart contract, its challenges and effect on financial market. The respondents for this study will be obtained from Forex Trading experts in Lagos State, Nigeria.

1.8 Limitation Of The Study

Like in every human endeavour, the researcher encountered slight constraints while carrying out the study. Insufficient funds tend to impede the efficiency of the researcher in sourcing for the relevant materials, literature, or information and in the process of data collection, which is why the researcher resorted to a limited choice of sample size. More so, the researcher simultaneously engaged in this study with other academic work. As a result, the amount of time spent on research will be reduced.

Moreover, the case study method utilized in the study posed some challenges to the investigator including the possibility of biases and poor judgment of issues. However, the investigator relied on respect for the general principles of procedures, justice, fairness, objectivity in observation and recording, and weighing of evidence to overcome the challenges.

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